What Drives Commodity Prices?
14 Pages Posted: 15 Apr 2020
Date Written: October 2014
This article examines common forces that drive the prices of 51 tradable commodities. We demonstrate that highly persistent movements of these prices are mostly due to the first common component, which is closely related to the U.S. nominal exchange rate. In particular, our simple factor‐based model outperforms the random walk model in out‐of‐sample forecast for the U.S. exchange rate. The second common factor and de‐factored idiosyncratic components are consistent with stationarity, implying short‐lived deviations from the equilibrium price dynamics. In concert, these results provide an intriguing resolution to the apparent inconsistency that arises from stable markets with nonstationary prices.
Keywords: Commodity prices, cross-section dependence, out-of-sample forecast, panel analysis of nonstationarity in idiosyncratic and common components, U.S. nominal exchange rate
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