Does Futures Speculation Stabilize Spot Prices? - Evidence From Metals Markets-

A. Enis Kocagil
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A. Enis Kocagil: PENN STATE UNIVERSITY, DEPT. OF MN. ECON., Postal: #221 WALKER BLDG., UNIVERSITY PARK, PA 16802 -5010

No 88-1993, Working Papers from Pennsylvania State University, Economics and Management

Abstract: The effects of speculation in futures markets has been a topic of a long lasting debate in both empirical and theoretical literature. Even though there have been several recent theoretical contributions, there are only a few studies which conduct a numeric analysis testing the empirical validity of the theories put forward. Thus, this study is an attempt to empirically test the relationship between speculation in futures markets and spot price volatility. The contribution of this study is two-fold: the theoretical framework which was developed by Driskill, McCafferty and Sheffrin (1991) is generalized and an empirical test of the hypothesis that futures speculation decreases spot price volatility is conducted using data on some metals markets, i.e. copper, gold, silver and aluminum. The model employed in the paper is a Muthian Rational Expectations Model, which assumes that spot and futures prices are determined simultaneously in an environment where uncertainty exists mainly due to three causes: (i) Consumer demand for the raw as well as the processed goods are uncertain, (ii) Storage costs fluctuate over time, and (iii) The price spread between the raw and processed goods is subject to uncertainty. Regression equations are estimated based on weekly futures and spot price series. Monte Carlo simulation methods are employed to test the accuracy of the estimated coefficients. The results, which are based on these four metals markets, for the period 1980-1990, reject the hypothesis that an increase in futures speculation intensity tends to decrease the spot price volatility, and thus, stabilizes spot markets.

Keywords: Stabilization; Speculation; Futures Markets; Metals Markets; Volatility (search for similar items in EconPapers)
Date: 1993-11
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