Estimating long run pricing models for copper futures prices

 

Abstract: The London Metal Exchange (LME) is a centre for spot and futures trading in the main industrially-used non-ferrous metals. In this paper, the market for 3-month LME copper futures contracts is analysed. The risk premium hypothesis and the cost-of-carry model are the standard theoretical models for pricing futures contracts, but these two models have rarely been estimated within a unified framework for metals futures. Single equation versions of the risk premium hypothesis and the cost-of-carry model are nested within a general model. If the spot price, futures price, interest rate and stock level variables contain stochastic trends, long run versions of the general model can be estimated within the cointegration framework. The long run pricing models are estimated using daily LME copper price data over the period 3 January 1989 to 30 September 1998. Likelihood ratio tests are used to test restrictions on the general model.

Keywords: Cost-of-carry, Risk premium hypothesis, Cointegration, Futures contracts, Industrial metals, Commodities, Metals