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Limits to arbitrage and hedging: Evidence from commodity markets

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  • Acharya, Viral V.
  • Lochstoer, Lars A.
  • Ramadorai, Tarun

Abstract

We build an equilibrium model of commodity markets in which speculators are capital constrained, and commodity producers have hedging demands for commodity futures. Increases in producers' hedging demand or speculators' capital constraints increase hedging costs via price-pressure on futures. These in turn affect producers' equilibrium hedging and supply decision inducing a link between a financial friction in the futures market and the commodity spot prices. Consistent with the model, measures of producers' propensity to hedge forecasts futures returns and spot prices in oil and gas market data from 1979 to 2010. 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 equilibrium commodity supply and prices.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 109 (2013)
Issue (Month): 2 ()
Pages: 441-465

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Handle: RePEc:eee:jfinec:v:109:y:2013:i:2:p:441-465

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Web page: http://www.elsevier.com/locate/inca/505576

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Keywords: Commodity markets; Futures pricing; Hedging; Limits to arbitrage;

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Cited by:
  1. Le Pen, Yannick & Sévi, Benoît, 2011. "Macro factors in oil futures returns," Economics Papers from University Paris Dauphine 123456789/11663, Paris Dauphine University.
  2. Sévi, Benoît & Le Pen, Yannick & Chevallier, Julien & Bunn, Derek, 2013. "Fundamental and Financial Influences on the Co-movement of Oil and Gas Prices," Economics Papers from University Paris Dauphine 123456789/11692, Paris Dauphine University.
  3. Yannick Le Pen & Benoît Sévi, 2013. "Futures trading and the excess comovement of commodity prices," Working Papers 2013-019, Department of Research, Ipag Business School.
  4. Lombardi, Marco J. & Van Robays, Ine, 2011. "Do financial investors destabilize the oil price?," Working Paper Series 1346, European Central Bank.
  5. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
  6. Ekeland, Ivar & Lautier, Delphine & Villeneuve, Bertrand, 2013. "A simple equilibrium model for a commodity market with spot trades and futures contracts," Economics Papers from University Paris Dauphine 123456789/11383, Paris Dauphine University.
  7. James D. Hamilton & Jing Cynthia Wu, 2013. "Risk Premia in Crude Oil Futures Prices," NBER Working Papers 19056, National Bureau of Economic Research, Inc.
  8. Celso Brunetti & David Reiffen, 2011. "Commodity index trading and hedging costs," Finance and Economics Discussion Series 2011-57, Board of Governors of the Federal Reserve System (U.S.).
  9. repec:ipg:wpaper:19 is not listed on IDEAS
  10. Gospodinov, Nikolay & Jamali, Ibrahim, 2013. "Monetary policy surprises, positions of traders, and changes in commodity futures prices," Working Paper 2013-12, Federal Reserve Bank of Atlanta.
  11. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2013. "Mortgage Hedging in Fixed Income Markets," FMG Discussion Papers dp722, Financial Markets Group.
  12. Derek Bunn & Julien Chevallier & Yannick Le Pen & Benoît Sévi, 2014. "Fundamental and Financial Influences on the Co-movement of Oil and Gas Prices," Working Papers 2014-414, Department of Research, Ipag Business School.
  13. Daskalaki, Charoula & Kostakis, Alexandros & Skiadopoulos, George, 2014. "Are there common factors in individual commodity futures returns?," Journal of Banking & Finance, Elsevier, vol. 40(C), pages 346-363.
  14. Bos Jaap & Molen Maarten van der, 2012. "A Bitter Brew? Futures Speculation and Commodity Prices," Research Memorandum 045, Maastricht University, Maastricht Research School of Economics of Technology and Organization (METEOR).
  15. Büyükşahin, Bahattin & Robe, Michel A., 2014. "Speculators, commodities and cross-market linkages," Journal of International Money and Finance, Elsevier, vol. 42(C), pages 38-70.

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