Economic Uncertainty and Commodity Futures Volatility

52 Pages Posted: 5 Dec 2014 Last revised: 7 Jan 2018

See all articles by Sumudu W. Watugala

Sumudu W. Watugala

Cornell University - Dyson School of Applied Economics and Management; University of Oxford - Oxford-Man Institute of Quantitative Finance

Date Written: January 5, 2015

Abstract

This paper investigates the dynamics of commodity futures volatility. I derive the variance decomposition for the futures basis to show how unexpected excess returns result from new information about the expected future interest rates, convenience yields, and risk premia. This motivates my empirical analysis of the volatility impact of economic and inflation regimes and commodity supply-demand shocks. Using data on major commodity futures markets and global bilateral commodity trade, I analyze the extent to which commodity volatility is related to fundamental uncertainty arising from increased emerging market demand and macroeconomic uncertainty, and control for the potential impact of financial frictions introduced by changing market structure and index trading. I find that a higher concentration in the emerging market importers of a commodity is associated with higher futures volatility. Commodity futures volatility is significantly predictable using variables capturing macroeconomic uncertainty. I examine the conditional variation in the asymmetric relationship between returns and volatility, and how this relates to the futures basis and sensitivity to consumer and producer shocks.

Keywords: Futures markets, commodities, emerging markets, concentration, volatility, uncertainty, power-law

JEL Classification: F36, G12, G13, G15, Q02

Suggested Citation

Watugala, Sumudu W., Economic Uncertainty and Commodity Futures Volatility (January 5, 2015). Paris December 2017 Finance Meeting EUROFIDAI - AFFI. Available at SSRN: https://ssrn.com/abstract=2533995 or http://dx.doi.org/10.2139/ssrn.2533995

Sumudu W. Watugala (Contact Author)

Cornell University - Dyson School of Applied Economics and Management ( email )

Ithaca, NY
United States

University of Oxford - Oxford-Man Institute of Quantitative Finance ( email )

Eagle House
Walton Well Road
Oxford, Oxfordshire OX2 6ED
United Kingdom

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