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The informational role of spot prices and inventories

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  • James L. Smith
  • Rex Thompson and Thomas K. Lee

Abstract

ABSTRACT We argue that fundamental determinants of speculative futures trading may have been misinterpreted by some as "excessive" speculation in the energy markets in recent years. Using a rational expectations approach, we show why and how differences in beliefs, as well as the volume of speculative futures trading, may rationally vary across commodities and through time. We demonstrate that equilibrium differences in beliefs are determined by characteristics of the underlying commodity, including storage costs, the amplitude of shocks, the accuracy of information available to informed investors, the numbers of informed and uninformed traders and the elasticity of demand and supply. We argue that speculative futures trading serves to reconcile these differences in beliefs, and may periodically rise or fall in concert with the underlying factors that create differences in beliefs. We also demonstrate that passive investors magnify equilibrium differences in beliefs and expand the scope for financial speculation, even though they do not themselves speculate.

Suggested Citation

  • James L. Smith & Rex Thompson and Thomas K. Lee, . "The informational role of spot prices and inventories," Journal of Energy Markets, Journal of Energy Markets.
    • Handle: RePEc:rsk:journ2:2424619
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    References listed on IDEAS

    as
    1. Tirole, Jean, 1982. "On the Possibility of Speculation under Rational Expectations," Econometrica, Econometric Society, vol. 50(5), pages 1163-1181, September.
    2. Harold Hotelling, 1931. "The Economics of Exhaustible Resources," Journal of Political Economy, University of Chicago Press, vol. 39(2), pages 137-137.
    3. Sanford J. Grossman, 1977. "The Existence of Futures Markets, Noisy Rational Expectations and Informational Externalities," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 44(3), pages 431-449.
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    Cited by:

    1. Lutz Kilian, 2014. "Oil Price Shocks: Causes and Consequences," Annual Review of Resource Economics, Annual Reviews, vol. 6(1), pages 133-154, October.

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    More about this item

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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