Banks that make markets in gold typically hedge the spot price with futures. Standard models assume the two instruments are highly correlated, and because the bid-ask for futures is often tighter than the spot spread, it makes sense for dealers to hedge with futures.
But standard pricing models might not have the full picture. A new paper published in sister title Risk.net this month suggests the connection between spot and futures prices in gold markets might be stronger than standard correlation.
“They are cointegrated,” says Olivier Guéant, professor of applied mathematics at Paris 1 Panthéon-Sorbonne University, of the relationship between the spot and futures markets for gold, “which means the difference between the two is stable over time. It’s not diffusive, but rather it oscillates and it’s statistically stationary”.
This…
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