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http://ssrn.com/abstract=1105546
 
 

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Limits to Arbitrage and Hedging: Evidence from Commodity Markets


Viral V. Acharya


New York University - Leonard N. Stern School of Business; Centre for International Finance and Regulation (CIFR); Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance

Tarun Ramadorai


University of Oxford - Said Business School; University of Oxford - Oxford-Man Institute of Quantitative Finance; Centre for Economic Policy Research (CEPR)

Lars A. Lochstoer


Columbia Business School - Finance and Economics

January 17, 2010

EFA 2009 Bergen Meetings Paper
AFA 2010 Atlanta Meetings Paper

Abstract:     
We build an equilibrium model with commodity producers who are averse to future cash flow variability, and hedge using futures. Their hedging demand is met by risk-constrained speculators. Increases in producers' hedging demand (speculators' risk- capacity) increase hedging costs via price-pressure on futures, reducing producers' inventory holdings, and thus spot prices. Consistent with our model, in oil and gas data from 1980-2006 producers' default risk forecasts hedging demand, futures risk-premia and spot prices; more so when speculative activity is lower. We conclude that limits to financial arbitrage can generate limits to hedging by firms, affecting prices in both asset and goods markets.

Number of Pages in PDF File: 57

Keywords: Corporate Hedging, Commodity Pricing, Default Risk, Incomplete Markets, Limits to Arbitrage

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Date posted: March 14, 2008 ; Last revised: July 27, 2011

Suggested Citation

Acharya, Viral V. and Ramadorai, Tarun and Lochstoer, Lars A., Limits to Arbitrage and Hedging: Evidence from Commodity Markets (January 17, 2010). EFA 2009 Bergen Meetings Paper; AFA 2010 Atlanta Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1105546 or http://dx.doi.org/10.2139/ssrn.1105546

Contact Information

Viral V. Acharya
New York University - Leonard N. Stern School of Business ( email )
44 West 4th Street
New York, NY NY 10012
United States
HOME PAGE: http://pages.stern.nyu.edu/~sternfin/vacharya/public_html/~vacharya.htm
Centre for International Finance and Regulation (CIFR) ( email )
Level 7, UNSW CBD Campus
1 O'Connell Street
Sydney, NSW 2000
Australia

Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
New York University (NYU) - Department of Finance
Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
Tarun Ramadorai
University of Oxford - Said Business School ( email )
Park End Street
Oxford, OX1 1HP
Great Britain
+44 1865 278 816 (Phone)
+44 1865 288 805 (Fax)
HOME PAGE: http://www.tarunramadorai.com
University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )
Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom
Centre for Economic Policy Research (CEPR) ( email )
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Lars A. Lochstoer (Contact Author)
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States

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