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Title: Cross-market return predictability, commodity and capital market integration Authors:  Emmanuel Eyiah-Donkor - University College Dublin (Ireland) [presenting]
John Cotter - University College Dublin (Ireland)
Valerio Poti - University College Dublin (Ireland)
Abstract: The cross-predictability of asset returns is studied using predictor variables specific to the commodity, stock and bond markets, and market integration thereof. We present evidence supporting the hypothesis that the commodity market is only partially integrated with the stock and bond markets. Extensive tests of predictability show that the information content of commodity-specific predictors has statistically significant predictive power for stock and bond excess returns at both short and long horizons. Portfolio analysis using mean-variance spanning tests confirms the robustness of the predictive regression tests. Specifically, we also find that the returns on a commodity predictability-based trading strategy constructed using stock and bond predictors do not improve the utility of a mean-variance investor with an existing portfolio composed of commodities and a commodity predictability-trading strategy constructed using commodity predictors. Our results have two implications. First, at the margin, different traders seem to price the strategies that exploit the predictability of each asset class. Second, there appear to be different marginal risk arbitrageurs for each asset class in line with the literature on limits to speculation and capital mobility. Traders in the stock and bond markets seem to value information from the commodity market but not vice versa.