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A simple equilibrium model for a commodity market with spot trades and futures contracts

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  • Ekeland, Ivar
  • Lautier, Delphine
  • Villeneuve, Bertrand

Abstract

We propose a simple equilibrium model, where the physical and the derivative markets of the commodity interact. There are three types of agents: industrial pro- cessors, inventory holders and speculators. Only the two first of them operate in the physical market. All of them, however, may initiate a position in the paper market, for hedging and/or speculation purposes. We give the necessary and sufficient con- ditions on the fundamentals of this economy for a rational expectations equilibrium to exist and we show that it is unique. This is the first contribution of the paper. Our model exhibits a surprising variety of behaviours at equilibrium, and our second contribution is that the paper offers a unique generalized framework for the analysis of price relationships. The model indeed allows for the generalization of hedging pressure theory, and it shows how this theory is connected to the storage theory. Meanwhile, it allows to study simultaneously the two main economic functions of derivative markets: hedging and price discovery. In its third contribution, through the distinction between the utility of speculation and that of hedging, the model illustrates the interest of a derivatives market in terms of the welfare of the agents.

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Bibliographic Info

Paper provided by Paris Dauphine University in its series Economics Papers from University Paris Dauphine with number 123456789/11383.

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Date of creation: May 2013
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Handle: RePEc:dau:papers:123456789/11383

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Keywords: Derivative markets; equilibrium; Industrial processors; inventory holders; speculator;

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  1. Roy Bailey and Marcus Chambers, . "A Theory of Commodity Price Fluctuations," Economics Discussion Papers, University of Essex, Department of Economics 432, University of Essex, Department of Economics.
  2. Bryan Routledge & Duane Seppi & Chester Spatt, . "Equilibrium Forward Curves for Commodities," GSIA Working Papers, Carnegie Mellon University, Tepper School of Business 1997-49, Carnegie Mellon University, Tepper School of Business.
  3. Anderson, Ronald W & Danthine, Jean-Pierre, 1983. "The Time Pattern of Hedging and the Volatility of Futures Prices," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 50(2), pages 249-66, April.
  4. Deaton, Angus & Laroque, Guy, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Wiley Blackwell, Wiley Blackwell, vol. 59(1), pages 1-23, January.
  5. Hendrik Bessembinder & Michael L. Lemmon, 2002. "Equilibrium Pricing and Optimal Hedging in Electricity Forward Markets," Journal of Finance, American Finance Association, American Finance Association, vol. 57(3), pages 1347-1382, 06.
  6. Hirshleifer, David, 1988. "Risk, Futures Pricing, and the Organization of Production in Commodity Markets," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 96(6), pages 1206-20, December.
  7. Acharya, Viral V. & Lochstoer, Lars A. & Ramadorai, Tarun, 2013. "Limits to arbitrage and hedging: Evidence from commodity markets," Journal of Financial Economics, Elsevier, Elsevier, vol. 109(2), pages 441-465.
  8. 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.
  9. 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, University of Chicago Press, vol. 60(1), pages 55-73, January.
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