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The precautionary demand for commodity stocks

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  • Boum-Jong Choe
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    Abstract

    This paper develops a theory of the precautionary demand for commodity stocks. It suggests that commodity stocks are held for precautionary purposes by producers, consumers, and intermediate processors, while speculators hold stocks on the expectation of capital gains from a subsequent price rise. Producer and consumer stocks usually account for the largest share of commercial stocks held at any point in time. For example, at the end of 1990, stocks held by producers and consumers of copper were 72 percent of all commercial stocks of the market economy countries. Yet, the theory explaining the behavior of this class of stocks has not progressed much beyond the concept of convenience yield, first introduced by Kaldor (1939). This paper proposes an alternative theory. Holding of stocks by producers and consumers is viewed as precautionary behavior towards output and price risks. As a theory of behavior towards risks, the precautionary stock demand model encompasses speculative demand by both producers and consumers. Furthermore, both stocks and futures are treated as precautionary instruments, in contrast to the dichotomy that only stocks provide convenience yield while futures are hedging instruments.

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    Bibliographic Info

    Paper provided by The World Bank in its series Policy Research Working Paper Series with number 935.

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    Date of creation: 31 Jul 1992
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    Handle: RePEc:wbk:wbrwps:935

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    Keywords: Access to Markets; Markets and Market Access; Economic Theory&Research; Environmental Economics&Policies; Non Bank Financial Institutions;

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    1. Lester G. Telser, 1958. "Futures Trading and the Storage of Cotton and Wheat," Journal of Political Economy, University of Chicago Press, vol. 66, pages 233.
    2. Marcus, Alan J & Modest, David M, 1984. "Futures Markets and Production Decisions," Journal of Political Economy, University of Chicago Press, vol. 92(3), pages 409-26, June.
    3. Miles S. Kimball, 1989. "Precautionary Saving in the Small and in the Large," NBER Working Papers 2848, National Bureau of Economic Research, Inc.
    4. Cootner, Paul H., 1967. "Speculation and Hedging," Food Research Institute Studies, Stanford University, Food Research Institute.
    5. Newbery, David M, 1989. "The Theory of Food Price Stabilisation," Economic Journal, Royal Economic Society, vol. 99(398), pages 1065-82, December.
    6. Feder, Gershon & Just, Richard E & Schmitz, Andrew, 1980. "Futures Markets and the Theory of the Firm under Price Uncertainty," The Quarterly Journal of Economics, MIT Press, vol. 94(2), pages 317-28, March.
    7. Williams,Jeffrey C. & Wright,Brian D., 1991. "Storage and Commodity Markets," Cambridge Books, Cambridge University Press, number 9780521326162.
    8. Holthausen, Duncan M, 1979. "Hedging and the Competitive Firm under Price Uncertainty," American Economic Review, American Economic Association, vol. 69(5), pages 989-95, December.
    9. French, George, 1986. "Price smoothing and inventory behavior," Journal of Economic Dynamics and Control, Elsevier, vol. 10(3), pages 353-366, September.
    10. Gustafson, Robert L., 1958. "Carryover levels for grains: A method for determining amounts that are optimal under specified conditions," Technical Bulletins 157231, United States Department of Agriculture, Economic Research Service.
    11. Deaton, Angus & Laroque, Guy, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Wiley Blackwell, vol. 59(1), pages 1-23, January.
    12. Anderson, Ronald W & Danthine, Jean-Pierre, 1983. "Hedger Diversity in Futures Markets," Economic Journal, Royal Economic Society, vol. 93(37), pages 370-89, June.
    13. Scheinkman, Jose A & Schechtman, Jack, 1983. "A Simple Competitive Model with Production and Storage," Review of Economic Studies, Wiley Blackwell, vol. 50(3), pages 427-41, July.
    14. Hirshleifer, David, 1989. "Futures Trading, Storage, and the Division of Risk: A Multiperiod Analysis," Economic Journal, Royal Economic Society, vol. 99(397), pages 700-719, September.
    15. Turnovsky, Stephen J, 1983. "The Determination of Spot and Futures Prices with Storable Commodities," Econometrica, Econometric Society, vol. 51(5), pages 1363-87, September.
    16. Rolfo, Jacques, 1980. "Optimal Hedging under Price and Quantity Uncertainty: The Case of a Cocoa Producer," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 100-116, February.
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