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Determinants of Trader Profits in Futures Markets

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “Determinants of Trader Profits in Futures Markets” delves into the intricate dynamics of trader profits in crude oil, gasoline, and heating oil futures markets.

Michaël Dewally, Louis H. Ederington, and Chitru S. Fernando use a unique proprietary data set to empirically test the predictions of commodity futures pricing models, deriving substantial insights. The study presents compelling evidence, indicating the polarity of profits between hedgers and speculators, aligning with the risk premium hypothesis, and the impactful influence of hedging pressure on trader profits.

Moreover, the analysis reveals profit variations linked to inventories and price volatility, aligning with the modern theory of storage. Importantly, these associations are established while considering macroeconomic risk factors and trader characteristics, offering nuanced insights into the momentum observed in commodity futures markets.

Abstract Of Paper

Using a unique proprietary data set of positions held by all large traders in the crude oil, gasoline, and heating oil futures markets, we use actual trader profits to test the predictions of various commodity futures pricing models. We find statistically and economically significant evidence that: (a) mean hedger profits are negative while speculator profits are positive, which is consistent with the risk premium hypothesis, (b) traders (whether speculators or hedgers) who hold long (short) positions when likely hedgers in aggregate are net short (long) have higher profits than traders whose net positions are aligned with likely hedgers, which is consistent with the hedging pressure hypothesis, and (c) profits on long positions vary inversely with inventories and directly with price volatility, which is consistent with the modern theory of storage. We establish these associations while controlling for macroeconomic risk factors that potentially affect futures returns and for trader characteristics. Our results indicate also that the momentum in commodity futures markets may be due largely to hedging pressure.

Original paper – Download PDF

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Author

Michaël Dewally
Towson University – Department of Finance

Louis H. Ederington
University of Oklahoma – Division of Finance

Chitru S. Fernando
University of Oklahoma – Michael F. Price College of Business

Conclusion

In conclusion, “Determinants of Trader Profits in Futures Markets” presents robust findings that shed light on the underlying factors influencing trader profits in crude oil, gasoline, and heating oil futures markets. Michaël Dewally, Louis H. Ederington, and Chitru S. Fernando’s research unearths the intricate interplay of various determinants, demonstrating the statistically and economically significant relationship between mean hedger profits and speculator profits, aligning with the risk premium hypothesis.

Moreover, the study uncovers the impact of hedging pressure on trader profits, revealing how traders’ positions in correlation with likely hedgers significantly influence their profitability.

The analysis further highlights the influence of inventories and price volatility on profits, corroborating the modern theory of storage.

Importantly, these associations are established while controlling for macroeconomic risk factors, providing nuanced insights into the momentum observed in commodity futures markets, attributing it largely to hedging pressure.

Related Reading:

Multi-Asset Seasonality and Trend-Following Strategies

Speculative Pressure

FAQ

Q1: What is the main focus of the research paper “Determinants of Trader Profits in Futures Markets” by Michaël Dewally, Louis H. Ederington, and Chitru S. Fernando?

A1: The research paper focuses on exploring the intricate dynamics of trader profits in crude oil, gasoline, and heating oil futures markets. It uses a unique proprietary dataset to empirically test predictions of commodity futures pricing models and provides substantial insights into the determinants of trader profits.

Q2: What are the key findings regarding the polarity of profits between hedgers and speculators, and the influence of hedging pressure on trader profits?

A2: The study reveals statistically and economically significant evidence indicating the polarity of profits between hedgers and speculators. Hedgers tend to have negative profits, while speculators exhibit positive profits, aligning with the risk premium hypothesis. Additionally, the research highlights the impactful influence of hedging pressure on trader profits, indicating that traders who hold positions opposite to likely hedgers in aggregate tend to have higher profits.

Q3: How does the research contribute to understanding the variations in trader profits related to inventories and price volatility in commodity futures markets?

A3: The analysis uncovers variations in trader profits linked to inventories and price volatility, supporting the modern theory of storage. The findings indicate that profits on long positions vary inversely with inventories and directly with price volatility. Importantly, these associations are established while considering macroeconomic risk factors and trader characteristics, providing nuanced insights into the factors influencing trader profitability in commodity futures markets.

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