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Explaining the Persistence of Commodity Prices

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  • Serena Ng
  • Francisco J. Ruge-Murcia

Abstract

This paper extends the Competitive Storage Model by incorporating prominent features of the production process and financial markets. This extension seems necessary since the basic model does not successfully explain the degree of serial correlation observed in actual data. To generate a high degree of price persistence, the model must incorporate agents that are willing to hold stocks more often than predicted by the basic model, so we include characteristics of the production and trading mechanisms to provide the required incentives. Specifically, we introduce (i) gestation lags in production with heteroskedastic supply shocks, (ii) multiperiod forward contracts, and (iii) a convenience return to inventory holding. Rational expectations solutions for twelve commodities are solved numerically. Simulations are then used to assess the effects of these extensions on the time-series properties of commodity prices. The results indicate that each feature accounts partly for the persistence as well as the occasional spikes observed in actual data. Evidence is also presented that the precautionary demand for stocks might play a substantial role in the dynamics of commodity prices.

Suggested Citation

  • Serena Ng & Francisco J. Ruge-Murcia, 2000. "Explaining the Persistence of Commodity Prices," Computational Economics, Springer;Society for Computational Economics, vol. 16(1/2), pages 149-171, October.
    • Handle: RePEc:kap:compec:v:16:y:2000:i:1/2:p:149-171
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    JEL classification:

    • 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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