First and Second Order Impacts of Speculation on Commodity Price Volatility

Ali Doroudian and James Vercammen

No 126947, Working Papers from Structure and Performance of Agriculture and Agri-products Industry (SPAA)

Abstract: This paper contributes to the debate on the link between speculation and price volatility in two ways. First, a simple CAPM model is used to derive the demand for commodity futures contracts by institutional investors, and this derived demand is then integrated into a simple rational expectations model of a commodity market with a demand for hedging by merchants. Second, a GARCH model is used to measure volatility in the U.S. rice market before and after the introduction of a futures contract for rice in 1994. The theoretical and empirical analysis both demonstrate that speculation results in a first order decrease in commodity price volatility, but part of this decrease will be offset by second order pricing distortions that are caused by institutional speculators.

Keywords: Crop Production/Industries; Financial Economics; Risk and Uncertainty (search for similar items in EconPapers)
Pages: 32
Date: 2012-02
New Economics Papers: this item is included in nep-agr
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:ags:spaawp:126947

DOI: 10.22004/ag.econ.126947

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