Abstract:
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The theory of storage suggests that the volatility of basis is negatively related to the level of inventory. In this paper, we propose to test the asymmetric volatility of basis within the ARMAX-GARCH model framework as a unified test to the theory of storage. Our empirical application uses six metal forward contracts (aluminum, copper, lead, tin, zinc, nickel ) traded in London Metal Exchange (LME) and gold and sliver futures traded in New York Mercantile Exchange (NYME). Several interesting empirical results are found: 1.) the volatilities of six London metal futures bases have exhibited strong negative asymmetric patterns, while no such patterns have been found in the basis volatility for NYME gold and sliver futures; and 2.) we found the previous direct test models of basis with daily data are mis-specificed, because they do not take account of asymmetric volatility in the residuals. Finally, in modeling dynamic behavior of basis (or futures spreads) for (consumption use) storable commodities, we recommend that researchers should consider the possibility of incorporating an asymmetric volatility term in their conditional variance function.
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