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Limits to Arbitrage and Hedging: Evidence from Commodity MarketsViral V. AcharyaNew York University - Leonard N. Stern School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER); New York University (NYU) - Department of Finance Tarun RamadoraiUniversity of Oxford - Said Business School; University of Oxford - Oxford-Man Institute of Quantitative Finance; Centre for Economic Policy Research (CEPR) Lars A. LochstoerColumbia 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 working papers seriesDate posted: March 14, 2008 ; Last revised: July 27, 2011Suggested CitationContact Information
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