Explaining the Persistence of Commodity Prices
AbstractThis paper extends the Competitive Storage Model by incorporating prominent features of the production process and financial markets. A major limitation of this basic model is that it cannot successfully explain the degree of serial correlation observed in actual data. The proposed extensions build on the observation that in order to generate a high degree of price persistence, a model must incorporate features such that agents are willing to hold stocks more often than predicted by the basic model. We therefore allow unique characteristics of the production and trading mechanisms to provide the required incentives. Specifically, the proposed models introduce (i) gestation lags in production with heteroskedastic supply shocks, (ii) multiperiod forward contracts, and (iii) a convenience return to inventory holding. The rational expectations solutions for twelve commodities are numerically solved. Simulations are then employed to assess the effects of the above extensions on the time series properties of commodity prices. Results indicate that each of the features above partially account for the persistence and occasional spikes observed in actual data. Evidence is presented that the precautionary demand for stocks might play a substantial role in the dynamics of commodity prices.
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Bibliographic InfoPaper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 374.
Length: 25 pages
Date of creation: 01 Apr 1997
Date of revision:
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commodity prices; persistence; speculative storage;
Other versions of this item:
- B4 - Schools of Economic Thought and Methodology - - Economic Methodology
- G1 - Financial Economics - - General Financial Markets
- Q1 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture
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