Study For Risk Of Cross-species Arbitrage On Commodity Futures

The original intention of commodity futures markets is to avoid the risk of fluctuations in the spot market price, while the futures arbitrage transactions resulting from unilateral futures transactions intended to avoid the risk of it. Currently, in order to pursue a stable income, the vast majority of large-scale international arbitrage funds are primarily or partly used of the way of arbitrage trading in the futures market. In the domestic futures market, investors have also become interest in the arbitrage transactions. According to the statistics which came from Dalian Commodity Exchange in 2008 that arbitrage trading volume was about 60% of the total value. It is precisely because that the risk of arbitrage trading patterns is less than the risk of trading futures unilateral, investors tend to ignore the existence of arbitrage risk. However, we have to re-examine the futures arbitrage trading risks after the two cases of huge losses of hedge funds occurred in 2006 in the United States.With the constant improvement in China's futures market structure and the increasing in the proportion of institutional investors, as well as the diversification of futures varieties, cross-species arbitrage has became more and more popular after another arbitrage trading patterns including intertemporal arbitrage and cross-market arbitrage.Compared with cross-market arbitrage and intertemporal arbitrage, the greatest feature of cross-species arbitrage is that the successful trade of it is largely depends on the correlation between different commodity futures. In order to ensure the success of arbitrage, investors not only need to determine accurately the different species correlation between futures, but also require more accurately forecast the trend of volatility spreads. Different characteristics of cross-species arbitrage increase the difficult of operating in futures market and make cross-species arbitrage became relatively more difficult and risky arbitrage transaction among all arbitrage patterns. In domestic futures market, due to cross-species mode of the carry trade is relatively more complex and is not widely enough in application in practice, the study of the risk of cross-species arbitrage is still rarely. The domestic researchers about futures market is still more biased in favor of the research of the risk of intertemporal arbitrage and cross-market arbitrage.In response to these conditions, this paper takes the risk of cross-species arbitrage as its research subject. In order to reveal the main risk of cross-species arbitrage including the risk of choice of the arbitrage portfolio and spread risk, this paper introduces the basic theory, the operation principle, the operating mode and the specific operation of cross-species arbitrage firstly. Following this content, this paper introduces the current main method of risk measurement which is called Value-at-Risk and compares the three calculated methods including variance-covariance models, historical simulation method and Monte Carlo simulation method of VAR for portfolio. On these bases, the paper chooses the historical simulation method as an approach in empirical study, and then briefly introduces the application principles in measure of the risk of cross-species arbitrage.Then, this paper selects the settlement price for copper and aluminum futures contract coming from Shanghai Futures Exchange which includes 1051 numbers as historical sample data. This part of the content describes the reasons for the selection of the arbitrage between copper and aluminum as the object of empirical analysis, followed by the analysis of arbitrage opportunity between copper and aluminum in the history of trading using the knowledge of mathematical statistics.Subsequently, the paper measures the VAR of copper/aluminum arbitrage based on futures position and margin respectively and the VAR of copper futures or aluminum futures trade using historical simulation method.The empirical analysis concludes the following results.First, Cross-species arbitrage of commodity futures can not completely circumvent the risk of unilateral trade, but also creates its own unique risks. Under the influence of a number of uncertainties, the risk of the arbitrage portfolio can not be ignored.Second, Different investors because of its attitude towards risk and risk tolerance may face different risks in process of arbitrage. Third, the risk of cross-species arbitrage is increased under margin system for futures and the lower is of margin, the greater is of risk.Fourth, it is more important to determine exactly the trend of spread for different futures considering the existence of margin.Fifth, the risk of the portfolio increases as the amount of initial investment increases under the condition of unchanged of the other parameters.Conclusions from the empirical analysis, cross-species arbitrage still has large risk because bilateral reverse hedging transactions can not completely evade the risk of unilateral investment transactions. Therefore, the last part of this article raised response measures to deal with the risk of cross-species arbitrage to investors and futures companies.