Portfolio Speculation and Commodity Price Volatility in a Stochastic Storage Model

James Vercammen and Ali Doroudian

American Journal of Agricultural Economics, 2014, vol. 96, issue 2, 517-532

Abstract: Simulated prices from a stochastic storage model are used to examine the price impacts of speculation by rational investors who diversify their financial portfolios by holding agricultural commodity futures. The main result is that rather than destabilizing commodity prices, as is commonly believed, portfolio speculation actually reduces price volatility. Portfolio speculation can potentially destabilize a commodity's price because the additional demand for long futures by speculators is expected to drive up the cash price during both periods of low net demand, when the cash price is below average, and periods of high net demand, when the cash price is above average. Our theoretical analysis demonstrates that the higher level of inventory that is associated with portfolio speculation results in a larger release of stocks during periods of high net demand. The price simulations reveal that this stock adjustment effect is strong since overall price volatility is smaller rather than larger with portfolio speculation.

Date: 2014
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American Journal of Agricultural Economics is currently edited by Madhu Khanna, Brian E. Roe, James Vercammen and JunJie Wu

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