Limits to Arbitrage and Hedging: Evidence from Commodity Markets

57 Pages Posted: 10 Sep 2013

See all articles by Viral V. Acharya

Viral V. Acharya

Professor; New York University - Leonard N. Stern School of Business; New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

Lars A. Lochstoer

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

Tarun Ramadorai

Imperial College London; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Multiple version iconThere are 6 versions of this paper

Date Written: January 2010

Abstract

Motivated by the literature on limits-to-arbitrage, we build an equilibrium model of commodity markets in which speculators are capital constrained, and commodity producers have hedging demands for commodity futures. Increases (decreases) in producers' hedging demand (speculators' risk capacity) increase hedging costs via price-pressure on futures, reduce producers' inventory holdings, and thus spot prices. Consistent with our model, producers' default risk forecasts futures returns,spot prices, and inventories in oil and gas market data from 1980-2006, and the component of the commodity futures risk premium associated with producer hedging demand rises when speculative activity reduces. We conclude that limits to financial arbitrage generate limits to hedging by producers, and affect both asset and goods prices.

Suggested Citation

Acharya, Viral V. and Acharya, Viral V. and Lochstoer, Lars A. and Ramadorai, Tarun, Limits to Arbitrage and Hedging: Evidence from Commodity Markets (January 2010). NYU Working Paper No. 2451/29543, Available at SSRN: https://ssrn.com/abstract=2323455

Viral V. Acharya (Contact Author)

New York University - Leonard N. Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States
2129980354 (Phone)
2129954256 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~vacharya

Professor ( email )

44 West 4th Street
Suite 9-160
New York, NY NY 10012
United States
2129980354 (Phone)
2129954256 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~vacharya

New York University (NYU) - Department of Finance

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Lars A. Lochstoer

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 )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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