Content area
Full text
1. Introduction
Commodity futures markets are increasingly in the focus of investors, in particular of the hedge funds, and China is no exception in this trend[1]. With its rapidly growing economy, China has some of the world’s most highly traded commodity futures including the contracts on copper, gold, iron ore, palm oil, and white sugar, which are some of the commodities that are considered in this paper[2].
In the aftermath of the Chinese stock market slump in the summer of 2015, the volume of commodity futures trading spiked due to the following three main reasons: first, the short selling restrictions in the Chinese stock market led the hedge funds to consider commodity futures as a main alternative, second the falling of commodity prices globally and the slowing down of the Chinese economy led the speculative investors to take short positions in the commodity futures betting that the slowdown of the Chinese economy might continue coupled with the slow global growth, and finally, since commodity futures prices have low correlation with the stock markets, while the Chinese stock market slumped, they offered important diversification benefits for the investors.
The increasing presence of hedge funds and investment banks in the commodity futures markets has the effect of increased use of quantitative trading strategies to generate statistical arbitrage profits. In the present paper, the performance of pairs trading is analyzed and by considering its maximum drawdown with different maximum holding periods for the spread position, our main contribution is to give evidence that at the shorter maximum holding periods, the profitability of pairs trading decreases in the Chinese commodity futures markets. The maximum drawdown, which is widely used in the hedge funds, is a function of the duration of the spread position. What is more, the relationship between the profitability and the maximum holding period for spreads appears to be robust both in time and across the different pairs. The intuition behind this conclusion is that if one does not have stop-loss barriers and can hold the spread positions for longer periods of time, then a higher premium can be received from pairs trading, which of course comes with the risk of a larger potential drawdown during this waiting time. Furthermore, using the complete data set of Chinese...