Price discovery and pairs trading potentials: the case of metals markets

Abstract

Purpose This study aims to validate the “expectancy theory” of asset pricing and explores the price discovery process in metals futures markets. Design/methodology/approach This paper adopts the Johansen cointegration and vector error correction model approach to investigate the potentials of Pairs trading in the metals market during the period 2008–2019. Findings The results find the price movements in metal markets are not random walk and the current “futures” prices are the reasonable estimate of the “spot” metal prices in future. This study does not notice any significant differences in the price efficiency across metals markets, which signal the effects of limited idiosyncratic forces in price transmission. Practical implications The research suggests the covert use of metal futures to make gains from arbitrage trading. Originality/value The study emphasizes the potential of “pair trading” in commodity market context that is seldom discussed in academic papers.