Download this Paper Open PDF in Browser

Limits to Arbitrage and Hedging: Evidence from Commodity Markets

51 Pages Posted: 9 Mar 2009 Last revised: 8 Jan 2013

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

Lars A. Lochstoer

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

Tarun Ramadorai

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

Multiple version iconThere are 6 versions of this paper

Date Written: January 8, 2013

Abstract

We build an equilibrium model of commodity markets in which speculators are capital constrained, and commodity producers have hedging demands for commodity futures. Increases in producers’hedging demand or speculators’capital constraints increase hedging costs via price-pressure on futures. These in turn affect producers’equilibrium hedging and supply decisioninducing a link between a fi…nancial friction in the futures market and the commodity spot prices. Consistent with the model, measures of producers’propensity to hedge forecasts futures returns and spot prices in oil and gas market data from 1979-2010. The component of the commodity futures risk premium associated with producer hedging demand rises when speculative activity reduces. We conclude that limits to fi…nancial arbitrage generate limits to hedging by producers, and affect equilibrium commodity supply and prices.

Keywords: commodities, hedging, limits to arbitrage, oil and gas, futures

JEL Classification: G12, G13, G14, G32

Suggested Citation

Acharya, Viral V. and Lochstoer, Lars A. and Ramadorai, Tarun, Limits to Arbitrage and Hedging: Evidence from Commodity Markets (January 8, 2013). Journal of Financial Economics (JFE), Forthcoming. Available at SSRN: https://ssrn.com/abstract=1354514

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

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

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

Paper statistics

Downloads
480
Rank
10,956
Abstract Views
2,106