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Futures Trading and the Excess Comovement of Commodity Prices

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We empirically reinvestigate the issue of excess comovement of commodity prices initially raised in Pindyck and Rotemberg (1990) and show that excess comovement, when it exists, can be related to hedging and speculative pressure in commodity futures markets. Excess comovement appears when commodity prices remain correlated even after adjusting for the impact of common factors. While Pindyck and Rotemberg and following contributions examine this issue using a relevant but arbitrary set of control variables, we use recent developments in large approximate factor models so that a richer information set can be considered and “fundamentals” are likely to be adequately modeled. We consider a set of 8 unrelated commodities along with 187 real and nominal macroeconomic variables from which 9 factors are extracted over the period 1993-2010. Our estimates provide evidence of a time-varying excess comovement which is only occasionally significant, even after controlling for heteroscedasticity. Interestingly, excess comovement is mostly significant in recent years when a large increase in the trading of commodities is observed and also in crisis periods. However, we show that this increase in trading activity alone has no explanatory power for the excess comovement. Conversely, measures of hedging and speculative pressure explain around 60% of the estimated excess comovement thereby showing the strong impact not only of the financialization process, but also the impact of behaviour of some categories of traders on the price of commodities and the fact that supply and demand variables are not the sole factors in determining equilibrium prices.

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Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1301.

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Length: 50 pages
Date of creation: Jan 2013
Date of revision: Jan 2013
Handle: RePEc:aim:wpaimx:1301

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Keywords: commodity excess comovement hypothesis; factors model; heteroscedasticity-corrected correlation; commodity index; futures trading.;

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Cited by:
  1. Julien Chevallier & Benoit Sevi, 2014. "A fear index to predict oil futures returns," Working Papers, Department of Research, Ipag Business School 2014-333, Department of Research, Ipag Business School.
  2. Julien Chevallier & Florian Ielpo & Ling-Ni Boon, 2013. "Common risk factors in commodities," Economics Bulletin, AccessEcon, vol. 33(4), pages 2801-2816.

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