Advanced Search
MyIDEAS: Login to save this article or follow this journal

Limits to arbitrage and hedging: Evidence from commodity markets

Contents:

Author Info

  • 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.

Download Info

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
File URL: http://www.sciencedirect.com/science/article/pii/S0304405X13000780
Download Restriction: Full text for ScienceDirect subscribers only

As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.

Bibliographic Info

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

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

as in new window
Handle: RePEc:eee:jfinec:v:109:y:2013:i:2:p:441-465

Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/505576

Related research

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

Other versions of this item:

Find related papers by JEL classification:

References

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
as in new window
  1. Erkko Etula, 2009. "Broker-dealer risk appetite and commodity returns," Staff Reports 406, Federal Reserve Bank of New York.
  2. Anderson, Ronald W & Danthine, Jean-Pierre, 1983. "Hedger Diversity in Futures Markets," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 93(37), pages 370-89, June.
  3. Gilson, Stuart C., 1989. "Management turnover and financial distress," Journal of Financial Economics, Elsevier, Elsevier, vol. 25(2), pages 241-262, December.
  4. Shleifer, Andrei & Vishny, Robert W, 1997. " The Limits of Arbitrage," Journal of Finance, American Finance Association, vol. 52(1), pages 35-55, March.
  5. Fehle, Frank & Tsyplakov, Sergey, 2005. "Dynamic risk management: Theory and evidence," Journal of Financial Economics, Elsevier, Elsevier, vol. 78(1), pages 3-47, October.
  6. Tufano, Peter, 1996. " Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
  7. Gromb, Denis & Vayanos, Dimitri, 2002. "Equilibrium and welfare in markets with financially constrained arbitrageurs," Journal of Financial Economics, Elsevier, Elsevier, vol. 66(2-3), pages 361-407.
  8. Adrian, Tobias & Shin, Hyun Song, 2010. "Liquidity and leverage," Journal of Financial Intermediation, Elsevier, Elsevier, vol. 19(3), pages 418-437, July.
  9. Jonathan B. Berk & Richard C. Green, 2002. "Mutual Fund Flows and Performance in Rational Markets," NBER Working Papers 9275, National Bureau of Economic Research, Inc.
  10. HOLMSTROM, Bengt, . "Moral hazard and observability," CORE Discussion Papers RP -379, Université catholique de Louvain, Center for Operations Research and Econometrics (CORE).
  11. Campbell, John & Thompson, Samuel P., 2008. "Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?," Scholarly Articles 2622619, Harvard University Department of Economics.
  12. Hirshleifer, David, 1989. "Futures Trading, Storage, and the Division of Risk: A Multiperiod Analysis," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 99(397), pages 700-719, September.
  13. Fama, Eugene F. & French, Kenneth R., 1989. "Business conditions and expected returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 25(1), pages 23-49, November.
  14. Coughlan, Anne T. & Schmidt, Ronald M., 1985. "Executive compensation, management turnover, and firm performance : An empirical investigation," Journal of Accounting and Economics, Elsevier, vol. 7(1-3), pages 43-66, April.
  15. Gary B. Gorton & Fumio Hayashi & K. Geert Rouwenhorst, 2007. "The Fundamentals of Commodity Futures Returns," NBER Working Papers 13249, National Bureau of Economic Research, Inc.
  16. Edward I. Altman, 1968. "Financial Ratios, Discriminant Analysis And The Prediction Of Corporate Bankruptcy," Journal of Finance, American Finance Association, vol. 23(4), pages 589-609, 09.
  17. Whitney K. Newey & Kenneth D. West, 1986. "A Simple, Positive Semi-Definite, Heteroskedasticity and AutocorrelationConsistent Covariance Matrix," NBER Technical Working Papers 0055, National Bureau of Economic Research, Inc.
  18. Jagannathan, Ravi & Wang, Zhenyu, 1996. " The Conditional CAPM and the Cross-Section of Expected Returns," Journal of Finance, American Finance Association, vol. 51(1), pages 3-53, March.
  19. Angus Deaton & Guy Laroque, 1990. "On The Behavior of Commodity Prices," NBER Working Papers 3439, National Bureau of Economic Research, Inc.
  20. Warner, Jerold B. & Watts, Ross L. & Wruck, Karen H., 1988. "Stock prices and top management changes," Journal of Financial Economics, Elsevier, Elsevier, vol. 20(1-2), pages 461-492, January.
  21. Litzenberger, Robert H & Rabinowitz, Nir, 1995. " Backwardation in Oil Futures Markets: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 50(5), pages 1517-45, December.
  22. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. " Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-58, December.
  23. DeMarzo, Peter M & Duffie, Darrell, 1995. "Corporate Incentives for Hedging and Hedge Accounting," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 743-71.
  24. Yakov Amihud & Baruch Lev, 1981. "Risk Reduction as a Managerial Motive for Conglomerate Mergers," Bell Journal of Economics, The RAND Corporation, vol. 12(2), pages 605-617, Autumn.
  25. Acharya, Viral V & Amihud, Yakov & Litov, Lubomir P., 2008. "Creditor Rights and Corporate Risk-taking," CEPR Discussion Papers 6697, C.E.P.R. Discussion Papers.
  26. Carter, Colin A. & Rausser, Gordon C. & Schmitz, Andrew, 1982. "Efficient asset portfolios and the theory of normal backwardation," Department of Agricultural & Resource Economics, UC Berkeley, Working Paper Series, Department of Agricultural & Resource Economics, UC Berkeley qt59c8m4x6, Department of Agricultural & Resource Economics, UC Berkeley.
  27. Weisbach, Michael S., 1988. "Outside directors and CEO turnover," Journal of Financial Economics, Elsevier, Elsevier, vol. 20(1-2), pages 431-460, January.
  28. Anderson, Ronald W & Danthine, Jean-Pierre, 1980. " Hedging and Joint Production: Theory and Illustrations," Journal of Finance, American Finance Association, vol. 35(2), pages 487-98, May.
  29. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
  30. Fama, Eugene F & French, Kenneth R, 1987. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums,and the Theory of Storage," The Journal of Business, University of Chicago Press, vol. 60(1), pages 55-73, January.
  31. Frans A. de Roon & Theo E. Nijman & Chris Veld, 2000. "Hedging Pressure Effects in Futures Markets," Journal of Finance, American Finance Association, vol. 55(3), pages 1437-1456, 06.
  32. Bryan Routledge & Duane Seppi & Chester Spatt, . "Equilibrium Forward Curves for Commodities," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-50, Carnegie Mellon University, Tepper School of Business.
  33. Jagannathan, Ravi, 1985. " An Investigation of Commodity Futures Prices Using the Consumption-based Intertemporal Capital Asset Pricing Model," Journal of Finance, American Finance Association, vol. 40(1), pages 175-91, March.
  34. David Hirshleifer, 1988. "Residual Risk, Trading Costs, and Commodity Futures Risk Premia," Review of Financial Studies, Society for Financial Studies, vol. 1(2), pages 173-193.
  35. Choe, Hyuk & Masulis, Ronald W. & Nanda, Vikram, 1993. "Common stock offerings across the business cycle : Theory and evidence," Journal of Empirical Finance, Elsevier, Elsevier, vol. 1(1), pages 3-31, June.
  36. Chang, Eric C, 1985. " Returns to Speculators and the Theory of Normal Backwardation," Journal of Finance, American Finance Association, vol. 40(1), pages 193-208, March.
  37. Smith, Clifford W. & Stulz, René M., 1985. "The Determinants of Firms' Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 20(04), pages 391-405, December.
  38. Bessembinder, Hendrik, 1992. "Systematic Risk, Hedging Pressure, and Risk Premiums in Futures Markets," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 637-67.
  39. Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
  40. Zhiguo He & Wei Xiong, 2008. "Delegated Asset Management, Investment Mandates, and Capital Immobility," NBER Working Papers 14574, National Bureau of Economic Research, Inc.
  41. G. David Haushalter, 2000. "Financing Policy, Basis Risk, and Corporate Hedging: Evidence from Oil and Gas Producers," Journal of Finance, American Finance Association, vol. 55(1), pages 107-152, 02.
  42. Kenneth A. Froot, 1999. "The Financing of Catastrophe Risk," NBER Books, National Bureau of Economic Research, Inc, number froo99-1, January.
  43. David Haushalter, 2001. "Why Hedge? Some Evidence From Oil And Gas Producers," Journal of Applied Corporate Finance, Morgan Stanley, vol. 13(4), pages 87-92.
  44. Ng, Victor K & Pirrong, Stephen Craig, 1994. "Fundamentals and Volatility: Storage, Spreads, and the Dynamics of Metals Prices," The Journal of Business, University of Chicago Press, vol. 67(2), pages 203-30, April.
  45. Kenneth A. Froot, 1999. "Introduction to "Financing of Catastrophe Risk, The"," NBER Chapters, in: The Financing of Catastrophe Risk, pages 1-22 National Bureau of Economic Research, Inc.
  46. Ing-Haw Cheng & Andrei Kirilenko & Wei Xiong, 2012. "Convective Risk Flows in Commodity Futures Markets," NBER Working Papers 17921, National Bureau of Economic Research, Inc.
  47. Bessembinder, Hendrik & Chan, Kalok, 1992. "Time-varying risk premia and forecastable returns in futures markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 32(2), pages 169-193, October.
  48. Coles, Jeffrey L. & Daniel, Naveen D. & Naveen, Lalitha, 2006. "Managerial incentives and risk-taking," Journal of Financial Economics, Elsevier, Elsevier, vol. 79(2), pages 431-468, February.
  49. Louis Ederington & Jae Ha Lee, 2002. "Who Trades Futures and How: Evidence from the Heating Oil Futures Market," The Journal of Business, University of Chicago Press, vol. 75(2), pages 353-374, April.
  50. Stulz, René M., 1984. "Optimal Hedging Policies," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 127-140, June.
  51. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, Elsevier, vol. 33(1), pages 3-56, February.
  52. Altinkilic, Oya & Hansen, Robert S, 2000. "Are There Economies of Scale in Underwriting Fees? Evidence of Rising External Financing Costs," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 191-218.
  53. Hirshleifer, David, 1990. "Hedging Pressure and Futures Price Movements in a General Equilibrium Model," Econometrica, Econometric Society, Econometric Society, vol. 58(2), pages 411-28, March.
  54. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, vol. 57(3), pages 1347-1382, 06.
Full references (including those not matched with items on IDEAS)

Citations

Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
as in new window

Cited by:
  1. Celso Brunetti & David Reiffen, 2011. "Commodity index trading and hedging costs," Finance and Economics Discussion Series, Board of Governors of the Federal Reserve System (U.S.) 2011-57, Board of Governors of the Federal Reserve System (U.S.).
  2. repec:ipg:wpaper:19 is not listed on IDEAS
  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. 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.
  5. Le Pen, Yannick & Sévi, Benoît, 2011. "Macro factors in oil futures returns," Economics Papers from University Paris Dauphine 123456789/11663, Paris Dauphine University.
  6. 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.
  7. 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).
  8. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
  9. Büyükşahin, Bahattin & Robe, Michel A., 2014. "Speculators, commodities and cross-market linkages," Journal of International Money and Finance, Elsevier, Elsevier, vol. 42(C), pages 38-70.
  10. Hamilton, James D. & Wu, Jing Cynthia, 2014. "Risk premia in crude oil futures prices," Journal of International Money and Finance, Elsevier, Elsevier, vol. 42(C), pages 9-37.
  11. Gospodinov, Nikolay & Jamali, Ibrahim, 2013. "Monetary policy surprises, positions of traders, and changes in commodity futures prices," Working Paper, Federal Reserve Bank of Atlanta 2013-12, Federal Reserve Bank of Atlanta.
  12. Lombardi, Marco J. & Van Robays, Ine, 2011. "Do financial investors destabilize the oil price?," Working Paper Series 1346, European Central Bank.
  13. Aytek Malkhozov & Philippe Mueller & Andrea Vedolin & Gyuri Venter, 2013. "Mortgage Hedging in Fixed Income Markets," FMG Discussion Papers, Financial Markets Group dp722, Financial Markets Group.
  14. 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.

Lists

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

Statistics

Access and download statistics

Corrections

When requesting a correction, please mention this item's handle: RePEc:eee:jfinec:v:109:y:2013:i:2:p:441-465. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei).

If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

If references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

Please note that corrections may take a couple of weeks to filter through the various RePEc services.