Financial Regulatory Arbitrage and Commodity Pricing

Abstract

We develop a DSGE framework to examine how financial regulatory arbitrage affects commodity pricing. In capital-control arbitrage, imported commodities bypass capital controls to exploit domestic-foreign interest rate differentials. In dual-track interest-rate arbitrage, commodities serve as collateral to capitalize on dual-track interest rate spreads. Our model illustrates the dynamics of prices, inventories and convenience yields, revealing how financial arbitrage re-establishes equilibrium after external shocks. Capital-control arbitrage decreases current commodity prices, raises inventory holdings, and lowers the convenience yield. Conversely, dual-track arbitrage increases prices, inventory, and convenience yields, weakening the negative inventory-yield relationship. Model calibration aligns with observed empirical patterns.

Keywords: financial regulatory arbitrage, commodity pricing, financialization of commodities, inventory-convenience yield relationship, capital account control, dual-track interest rates