Stochastic Fundamental Volatility, Speculation, and Commodity Storage
26 Pages Posted: 11 Feb 2009
Date Written: October 17, 2008
Abstract
Commodity price spikes are often accompanied by allegations that speculative excess has caused prices to depart dramatically from levels justified by fundamentals. Since prices guide real resource allocations, distortions in prices should lead to distortions in real variables, such as inventories. In 2005-2006 critics of speculation pointed to anomalous increases in stocks in the face of rising prices as evidence of speculative distortion. This article demonstrates, however, that when the volatility of fundamental shocks is stochastic, such comovements occur in competitive markets. Since agents use inventories to smooth out the effects of unpredictable net demand shocks, a positive volatility shock induces an increase in inventories. For inventories to increase (holding the level of the net demand shock constant), prices must rise to reduce consumption and encourage production. The analysis implies that an increase in speculative stocks is at best a necessary, but not sufficient, condition for the existence of a speculative price distortion.
Keywords: commodity prices, speculation, storage
JEL Classification: G12, G13
Suggested Citation: Suggested Citation
Do you have a job opening that you would like to promote on SSRN?
Paper statistics
Recommended Papers
-
The Tactical and Strategic Value of Commodity Futures
By Claude B. Erb and Campbell R. Harvey
-
The Tactical and Strategic Value of Commodity Futures
By Claude B. Erb and Campbell R. Harvey
-
The Long-Run Behavior of Commodity Prices: Small Trends and Big Variability
-
The Fundamentals of Commodity Futures Returns
By Gary B. Gorton, Fumio Hayashi, ...
-
The Fundamentals of Commodity Futures Returns
By Gary B. Gorton, Fumio Hayashi, ...
-
Momentum Strategies in Commodity Futures Markets
By Joƫlle Miffre and Georgios Rallis