Dynamics of Arbitrage
63 Pages Posted: 25 Jul 2018
Date Written: June 4, 2018
This paper examines the mechanism behind cash-and-carry arbitrage by studying the U.S. crude oil market. Sizable arbitrage-related inventory movements occur primarily at the NYMEX futures contract delivery point, but no evidence of such movements exists at other U.S. storage locations where, instead, operational factors explain most inventory changes. We add to the Theory of Storage literature by introducing two new features. First, due to arbitrageurs contracting ahead, inventories respond to not only contemporaneous but also lagged futures spreads. Second, storage capacity limits can impede cash-and-carry arbitrage leading to the persistence of unexploited arbitrage opportunities. Our findings suggest that arbitrage-induced inventory movements are, on average, price stabilizing.
Keywords: theory of storage, commodity markets, cash-and-carry arbitrage, financialization, spot oil markets, oil futures markets, oil storage
JEL Classification: G13, G18, Q41
Suggested Citation: Suggested Citation