Do Institutional Traders Predict Bull and Bear Markets?

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Transcription:

Do Institutional Traders Predict Bull and Bear Markets? Celso Brunetti Federal Reserve Board Bahattin Büyükşahin International Energy Agency Jeffrey H. Harris Syracuse University

Overview Speculator (hedge fund, swap dealer and arbitrageur) positions have grown in commodity markets this decade Concurrently, commodity prices have fluctuated greatly Can these trader positions shed light on the probability of continuations/reversals in the market? Crude Oil Corn Mini-S&P Brunetti, Buyuksahin, Harris: Do Institutional Traders

Results: Preview Market fundamentals contribute significantly Crude Oil: Business cycle, credit risk (TED spread), MSCI world index, expected inflation Corn: Biofuel program Mini-S&P: Business cycle, credit risk (TED spread), MSCI world index, expected inflation Incremental information from hedge funds, swap dealers and arbitrageurs

Outline of the Presentation Motivation Data Econometrics Results Final remarks & future research

Motivation Abreuand Brunnermeier (2002, 2003) model Syncronization Risk Futures markets reflect these characteristics competitive, rational arbitrageurs complex to determine supply and demand potential for sequential awareness of price deviations from fundamental value both long and short positions expose arbitrageurs to significant holding costs--mark-to-market margins Brunetti, Buyuksahin, Harris: Do Institutional Traders

Our Approach Regime switching models with Time varying transition probabilities Conditional on trader positions (changes) Regime switching literature Maheu, McCurdy & Song (2009): Bull and bear markets Blazsek& Downarowicz(2009); Alexander & Dimitriu (2005): Hedge fund returns Gray (1996), Dueker(1997) Brunetti et al. (2007)

Related Literature Hedge funds in financial crises Fung and Hsieh (2000): Mexico Tequila Crisis 1994 Brown, Goetzman and Park (2000): Asian Crisis 1997 Brunnermeier& Nagel (2004): Internet Bubble 2001 Edwards (1999): LTCM Liquidity Crisis Hedge funds and swap dealers in futures markets Brorsen& Irwin (1987): Volatility and hedge fund position Irwin & Holt (2004): Volume and volatility in ag futures Haigh, Hranaiova& Overdahl(2007) Hedge funds and energy prices Boyd, Buyuksahin, Haigh& Harris (2011) and Brunetti, Buyuksahin and Harris (2012) Herding among hedge funds Buyuksahin& Harris (2011): Crude oil prices and positions Buyuksahin, Haigh, Harris, Overdahl, & Robe (2011): Swap dealers and cointegration across crude oil contracts Brunetti, Buyuksahin & Harris (2011): Prices, positions and volatility Buyuksahin and Robe (2010, 2011); Linkages between commodities and equity markets

Our Data Detailed daily CFTC data Daily settlement prices returns Daily positions of hedge funds, swap dealers and arbitrageurs trading activity January 3, 2005 March 19, 2009 Large Trader Reporting System (weekly at CFTC.gov) Commercial Traders (Manufacturers, Producers, etc) Swap Dealers* Hedge Funds (Managed Money)* Dealers Roll over strategy: Use the nearby contract until the open interest of the nearby contract falls below that of the next-to-nearby contract

Crude Oil Prices 160 140 120 100 Positions 80 60 40 20 0

Table 1: Crude Oil Hedge Funds Swap Dealers Returns Positions Changes Positions Changes Mean -0.010 12,011-837.3 81,895 232.9 Median 0.067 13,007-899.0 79,109-64.50 Max 13.34 90,993 24,833 205,888 25,001 Min -13.06-65,306-53,963-17,907-29,135 Std. Dev. 2.441 31,240 65,47 38,949 7,301 Skewness -0.206-0.086-0.669 0.572 0.002 Kurtosis 5.789 2.481 8.401 2.993 4.408 ADF (p-value) 0.000 0.000 0.000 0.000 0.000

Trader Participation Trends: Crude Oil Contribution to the WTI Futures Open Interest: All Maturities (July 2000 - August 2008) 100% 80% 60% 40% 20% Jul-00 Oct-00 Jan-01 Apr-01 Jul-01 Oct-01 Jan-02 Apr-02 Jul-02 Oct-02 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 0% FBT NRP HF AD AP AM NC AS

Crude Oil 250000 160 200000 AS 140 150000 HF 120 price 100 Positions 100000 50000 80 Price 60 0 40-50000 20-100000 0

Corn 400000 9 300000 200000 AS HF price 8 7 6 Positions 100000 5 4 Price 0 3-100000 2 1-200000 0

Mini-S&P500 800000 600000 400000 200000 0-200000 -400000-600000 -800000-1000000 -1200000 1800 1600 1400 1200 1000 800 600 400 200 0 Jan-03 Apr-03 Jul-03 Oct-03 Jan-04 Apr-04 Jul-04 Oct-04 Jan-05 Apr-05 Jul-05 Oct-05 Jan-06 Positions Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07 Jan-08 Apr-08 Jul-08 Oct-08 Jan-09 Price FA HF price

Table 2: Long/Short Percentage of Open Interest Panel A: Crude Oil Hedge Funds Swap Dealers Long Short Long Short Mean 25.04% 17.90% 38.86% 6.29% Min 7.12% 2.25% 12.06% 0.84% Max 48.19% 39.56% 59.82% 20.75% St. Dev. 7.68% 9.30% 9.11% 3.14% Panel B: Corn Mean 16.45% 17.43% 37.40% 2.58% Min 2.48% 1.15% 0.40% 0.00% Max 39.21% 44.23% 69.43% 14.22% St. Dev. 6.70% 8.95% 12.94% 3.19% Panel C: mini-s&p500 Hedge Funds Arbitrageurs Mean 8.31% 8.05% 15.85% 35.81% Min 0.60% 0.47% 2.69% 18.21% Max 19.47% 21.00% 65.64% 68.74% Brunetti, St. Dev. Buyuksahin, Harris: Do 3.54% Institutional Traders 3.36% Predict 10.03% 9.21% Bull and Bear Markets?

The Model Starting point: Simple GARCH

Regime Switching: Conditional Mean where 0 indicates a bear market and 1 indicates a bull market

Regime Switching: Conditional Variance

Regime Switching: Transition Probabilities where 0 indicates bear market and 1 indicates bull market Z s are either the standardized daily closing net futures positions (Positions) or position changes (Changes)

Estimation Procedure Calculate the EM algorithm recursively, each day Max(Log-Likelihood) conditional on prior day Iterate through the full sample to obtain a daily estimate of the transition probabilities Computer-intensive procedure!

Crude Oil P(1,0): Explanatory Variable: Hedge Fund Position Levels 160 0,35 140 0,3 120 0,25 100 0,2 80 60 0,15 40 0,1 20 0,05 0 0 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 Price Probability Brunetti, Buyuksahin, Harris: Do Institutional Traders

Crude Oil P(0,1): Explanatory Variable: Hedge Fund Position Changes 160 0,8 140 0,7 120 0,6 100 0,5 80 0,4 60 0,3 40 0,2 20 0,1 0 0 Jan-03 Mar-03 May-03 Jul-03 Sep-03 Nov-03 Jan-04 Mar-04 May-04 Jul-04 Sep-04 Nov-04 Jan-05 Mar-05 May-05 Jul-05 Sep-05 Nov-05 Jan-06 Mar-06 May-06 Jul-06 Sep-06 Nov-06 Jan-07 Mar-07 May-07 Jul-07 Sep-07 Nov-07 Jan-08 Mar-08 May-08 Jul-08 Sep-08 Nov-08 Jan-09 Mar-09 Price Probability

Main Findings: Table 3 Crude Oil The model identifies 2 regimes: Low Volatility Bull and High Volatility Bear markets Table 3 γ represents the ratio of bear market volatility to bull market volatility Brunetti, Buyuksahin, Harris: Do Institutional Traders

Parameters Model(1,1) Positions Changes Positions Changes Bear Market Mean Return (µ 0 ) -1.292*** (0.242) -1.312*** (0.260) -1.252*** (0.172) -1.339*** (0.300) -1.276*** (0.234) Bull Market Mean Return (µ 1 ) 0.565*** (0.186) 0.541*** (0.166) 0.627*** (0.117) 0.552*** (0.185) 0.557*** (0.164) ω 0.000 0.000 0.000 0.000 0.000 (0.002) (0.001) (0.000) (0.000) (0.003) γ 18.96*** 18.966*** 21.800*** 18.966*** 18.966*** (3.231) (3.239) (3.962) (4.009) (2.802) α 0.055*** 0.056*** 0.057*** 0.054*** 0.056*** (0.014) (0.014) (0.014) (0.015) (0.013) β 0.939*** 0.938*** 0.935*** 0.939*** 0.937*** (0.018) (0.016) (0.017) (0.017) (0.010) P 00 -Constant 0.266 (0.269) 0.409 (0.320) 0.208 (0.173) 0.456 (0.459) 0.106 (0.070) P 00 Z t-1 0-0.363*** (0.083) 0.374 (0.379) -0.328 (0.237) 0.106-0.474 P 00 Z t-1 <0 0.022 (0.042) -0.068 (0.314) 0.305 (0.365) -0.382* (0.213) P 11 -Constant 1.066*** (0.240) 1.319*** (0.253) 1.239*** (0.220) 1.074*** (0.207) 1.066*** (0.153) P 11 Z t-1 0-0.332* (0.200) -0.227 (0.199) -0.037 (0.109) -0.141 (0.172) P 11 Z t-1 <0 0.165** (0.064) 0.372* (0.211) -0.023 (0.018) -0.174 (0.234) θ -0.128*** -0.126*** -0.136*** -0.127*** -0.128*** (0.038) (0.036) (0.032) (0.043) (0.018) AIC 6860.72 6855.23 6857.14 6858.37 6857.67 LogLikelihood -3421.36-3414.62-3415.57-3416.18-3415.84 Brunetti, Buyuksahin, Harris: Do Institutional Traders

Main Findings: Table 3 Crude Oil The model identifies 2 regimes: Low Volatility Bull and High Volatility Bear markets Table 3 γ represents the ratio of bear market volatility to bull market volatility Volatility is highly persistent α+βclose to 1.0

Parameters Model(1,1) Positions Changes Positions Changes Bear Market Mean Return (µ 0 ) -1.292*** (0.242) -1.312*** (0.260) -1.252*** (0.172) -1.339*** (0.300) -1.276*** (0.234) Bull Market Mean Return (µ 1 ) 0.565*** (0.186) 0.541*** (0.166) 0.627*** (0.117) 0.552*** (0.185) 0.557*** (0.164) ω 0.000 0.000 0.000 0.000 0.000 (0.002) (0.001) (0.000) (0.000) (0.003) γ 18.96*** 18.966*** 21.800*** 18.966*** 18.966*** (3.231) (3.239) (3.962) (4.009) (2.802) α 0.055*** 0.056*** 0.057*** 0.054*** 0.056*** (0.014) (0.014) (0.014) (0.015) (0.013) β 0.939*** 0.938*** 0.935*** 0.939*** 0.937*** (0.018) (0.016) (0.017) (0.017) (0.010) P 00 -Constant 0.266 (0.269) 0.409 (0.320) 0.208 (0.173) 0.456 (0.459) 0.106 (0.070) P 00 Z t-1 0-0.363*** (0.083) 0.374 (0.379) -0.328 (0.237) 0.106-0.474 P 00 Z t-1 <0 0.022 (0.042) -0.068 (0.314) 0.305 (0.365) -0.382* (0.213) P 11 -Constant 1.066*** (0.240) 1.319*** (0.253) 1.239*** (0.220) 1.074*** (0.207) 1.066*** (0.153) P 11 Z t-1 0-0.332* (0.200) -0.227 (0.199) -0.037 (0.109) -0.141 (0.172) P 11 Z t-1 <0 0.165** (0.064) 0.372* (0.211) -0.023 (0.018) -0.174 (0.234) θ -0.128*** -0.126*** -0.136*** -0.127*** -0.128*** (0.038) (0.036) (0.032) (0.043) (0.018) AIC 6860.72 6855.23 6857.14 6858.37 6857.67 LogLikelihood -3421.36-3414.62-3415.57-3416.18-3415.84

Main Findings: Table 3 Crude Oil The model identifies 2 regimes: Low Volatility Bull and High Volatility Bear markets Table 3 γ represents the ratio of bear market volatility to bull market volatility Volatility is highly persistent α+βclose to 1.0 Hedge Fund Positions add incremental value Significant coefficients Lower AIC, Higher Log-Likelihood Swap Dealer Positions not so much

Parameters Model(1,1) Positions Changes Positions Changes Bear Market Mean Return (µ 0 ) Bull Market Mean Return (µ 1 ) ω γ α β -1.292*** (0.242) 0.565*** (0.186) 0.000 (0.002) 18.96*** (3.231) 0.055*** (0.014) 0.939*** (0.018) P 00 -Constant 0.266 (0.269) P 00 Z t-1 0 P 00 Z t-1 <0 P 11 -Constant 1.066*** (0.240) P 11 Z t-1 0 P 11 Z t-1 <0 θ -0.128*** (0.038) Brunetti, Buyuksahin, Harris: Do Institutional Traders -1.312*** (0.260) 0.541*** (0.166) 0.000 (0.001) 18.966*** (3.239) 0.056*** (0.014) 0.938*** (0.016) 0.409 (0.320) -0.363*** (0.083) 0.022 (0.042) 1.319*** (0.253) -0.332* (0.200) 0.165** (0.064) -0.126*** (0.036) -1.252*** (0.172) 0.627*** (0.117) 0.000 (0.000) 21.800*** (3.962) 0.057*** (0.014) 0.935*** (0.017) 0.208 (0.173) 0.374 (0.379) -0.068 (0.314) 1.239*** (0.220) -0.227 (0.199) 0.372* (0.211) -0.136*** (0.032) -1.339*** (0.300) 0.552*** (0.185) 0.000 (0.000) 18.966*** (4.009) 0.054*** (0.015) 0.939*** (0.017) 0.456 (0.459) -0.328 (0.237) 0.305 (0.365) 1.074*** (0.207) -0.037 (0.109) -0.023 (0.018) -0.127*** (0.043) -1.276*** (0.234) 0.557*** (0.164) 0.000 (0.003) 18.966*** (2.802) 0.056*** (0.013) 0.937*** (0.010) 0.106 (0.070) 0.106-0.474-0.382* (0.213) 1.066*** (0.153) -0.141 (0.172) -0.174 (0.234) -0.128*** (0.018) AIC 6860.72 6855.23 6857.14 6858.37 6857.67 LogLikelihood -3421.36-3414.62-3415.57-3416.18-3415.84

Caveats Transition Probabilities are somewhat low No normative standard Incremental information may be related to fundamental information hedge fund positions simply reflect fundamentals Explore this possibility Table 6: Positions are related to fundamental factors! Table 7: Transition probabilities controlling for fundamental factors

Table 6: Trader Positions & Fundamentals AutoRegressive Component ADS Business Cycle Positions Changes Positions Changes 0.942*** (0.009) 961.5*** (364.3) TED Spread -629.8* (380.2) MSCI Equity Index Expected Inflation -139.8 (241.2) -4663*** (1175) Panel A: Crude Oil Hedge Funds -0.061*** (0.024) 425.9 (330.9) -511.9* (309.8) 154.4 (181.75) -1835** (923.4) 0.940*** (0.051) -652.6 (458.4) 962.7 (755.2) 255.9 (231.8) 3768** (1598) Swap Dealers 0.455*** (0.023) -176.9 (259.5) -269.6 (368.6) 180.2 (125.4) -703.5 (727.7) Adjusted-R 2 92.25% 1.11% 92.14% 21.07%

Table 6: Trader Positions & Fundamentals Corn positions related to biofuel program Mini-S&P500 Hedge fund positions related to world equities (MSCI) Arbitrageur positions related to Credit (TED spread) World equities (MSCI)

Table 7: Transition Probabilities, Fundamentals & Positions Levels Changes Levels Changes P 01 P 10 P 01 P 10 P 01 P 10 P 01 P 10 i=hedge Fund Positions i=swap Dealer Positions AR 0.613*** (0.022) 0.643*** (0.024) 0.143*** (0.043) 0.423*** (0.023) 0.472*** (0.025) 0.422*** (0.027) 0.372*** (0.028) 0.457*** (0.027) Trader i 1.1e-6*** (1.4e-7) 3.2e-7*** (8.4e-8) -3.4e-7 (6.5e-7) -5.0e-6*** (4.0e-7) 1.4e-7*** (5.3e-7) -5.5e-8 (1.7e-7) 8.3e-8 (1.8e-7) 6.5e-7** (2.9e-7) ADS 0.004*** (0.001) TED -0.002* Spread (0.001) -0.001 (0.001) 0.003*** (0.001) 0.003 (0.003) 0.002 (0.003) -0.009*** (0.003) -0.001 (0.004) 0.002** (0.001) 0.001 (0.001) -0.006** (0.003) -3.8e-4 (0.003) 0.003** (0.001) -4.6e-4 (0.002) -0.006** (0.003) -0.002 (0.003) MSCI Equity Exp. Infl. 0.218*** (0.056) -1.748*** (0.382) -0.221*** (0.051) 0.108 (0.438) 0.165 (0.116) -1.316* (0.673) -0.746*** (0.155) 2.103** (0.949) 0.262*** (0.054) -0.392 (0.322) -0.598*** (0.159) 1.694* (0.987) 0.067 (0.075) -1.149*** (0.422) -0.743*** (0.145) 1.273 (0.947) R 2 49.52% 42.97% 2.78% 34.59% 24.09% 19.05% 15.61% 23.34%

Main Findings: Table 7 Crude Oil Crude Oil transition probabilities depend on fundamentals: Business Cycle (ADS) Expected Inflation Credit Risk (TED Spread) World stock market (MSCI) Hedge Fund Positions are incrementally significant Swap Dealer Positions are too! Similar results hold for corn and mini-s&p markets

Conclusions Hedge fund and arbitrageur positions driven by fundamentals Swap dealer positions largely invariant to fundamentals Speculative positions have incremental explanatory power beyond fundamentals Contribute significantly to transition probabilities between low volatility bull markets and high volatility bear markets Further research on similar non-linear dynamics may hold promise for discerning bubble patterns a priori

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