Limits to Arbitrage and Hedging: Evidence from Commodity Markets

Viral Acharya, Lars A. Lochstoer and Tarun Ramadorai

No 16875, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Motivated by the literature on limits-to-arbitrage, we build an equilibrium model of commodity markets in which speculators are capital constrained, and commodity producers have hedging demands for commodity futures. Increases (decreases) in producers' hedging demand (speculators' risk-capacity) increase hedging costs via price-pressure on futures, reduce producers' inventory holdings, and thus spot prices. Consistent with our model, producers' default risk forecasts futures returns, spot prices, and inventories in oil and gas market data from 1980-2006, and the component of the commodity futures risk premium associated with producer hedging demand rises when speculative activity reduces. We conclude that limits to financial arbitrage generate limits to hedging by producers, and affect both asset and goods prices.

JEL-codes: G12 G13 G24 G33 (search for similar items in EconPapers)
Date: 2011-03
Note: AP CF
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (14)

Published as “Limits to Arbitrage and Hedging: Evidence from Commodity Markets” with Lars Lochstoer and Tarun Ramadorai, forthcoming, Journal of Financial Economics.

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Related works:
Journal Article: Limits to arbitrage and hedging: Evidence from commodity markets (2013)
Working Paper: Limits to Arbitrage and Hedging: Evidence from Commodity Markets (2009)
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