Limits to Arbitrage and Hedging: Evidence from Commodity Markets

57 Pages Posted: 14 Mar 2008 Last revised: 15 Dec 2015

Viral V. Acharya

New 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 Ramadorai

Imperial College London; Centre for Economic Policy Research (CEPR)

Lars A. Lochstoer

University of California, Los Angeles (UCLA) - Anderson School of Management

Multiple version iconThere are 6 versions of this paper

Date Written: January 17, 2010

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.

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

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: https://ssrn.com/abstract=1105546 or http://dx.doi.org/10.2139/ssrn.1105546

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 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

Imperial College London ( email )

South Kensington Campus
Exhibition Road
London, Greater London SW7 2AZ
United Kingdom

HOME PAGE: http://www.tarunramadorai.com

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

Lars A. Lochstoer (Contact Author)

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

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