Jumping Hedges: An Examination of Movements in Copper Spot and Futures Markets

Abstract

Price risk is an important factor for both copper purchasers who use the commodity as a major input in their production process and copper refiners who must deal with cash-flow volatility. We use information from NYMEX cash and futures prices to examine optimal hedging behaviour for agents in copper markets. We propose a bivariate GARCH-jump model with autoregressive jump intensity to capture the features of the joint distribution of cash and futures returns over two sub-periods with different dominant pricing regimes. We find that during the earlier producer-pricing regime this specification is not needed, while for the later exchange pricing era jump dynamics stemming from a common jump across cash and futures series are significant in explaining the dynamics in both our daily and weekly data sets. We use the results from our model to undertake both within-sample and out-of-sample hedging exercises. These results indicate that there are important gains to be made from a time-varying optimal hedging strategy that incorporates the information from the common jump dynamics.

Keywords: Bivariate GARCH, Autoregressive Jump Intensity, Optimal Hedge Ratio, Copper Prices

JEL Classification: C32, C52, G13