Interest Rates And The Volatility And Correlation Of Commodity Prices

We propose a novel explanation for the observed increase in the correlation of commodity prices over the past decade. In contrast to theories that rely on the increased influence of financial speculators, we examine the effect of interest rates on the volatility and correlation of commodity prices via a panel GARCH model. In theory, lower interest rates decrease the volatility of prices, as lower inventory costs promote the smoothing of transient shocks, and increase price correlation if common shocks are more persistent than idiosyncratic shocks. Empirically, we find that price volatility attributable to transitory shocks declines with interest rates, whereas particularly for metals prices, price correlation increases as interest rates decline.