IDEAS home Printed from https://ideas.repec.org/p/adb/adbwps/2135.html
   My bibliography  Save this paper

Working Paper 205 - Volatility and Co-movement in Commodity Prices- New Evidence

Author

Listed:

Abstract

In this paper we show that commodity price co-movements between petroleum and other commodities, although infrequent, are not unique to recent periods, as alluded to in the current literature. We find that much of the volatility in commodity prices over long time spans is caused by economic fundamentals. Conditional covariances of unrelated commodities are very small in ordinary circumstances, as expected. After accounting for economic fundamentals, we find no evidence of excess co-movement between groups of commodity pairs. In a framework where commodity prices are influenced by common macroeconomic variables that determine the supply and demand for commodities, we show that conditional covariances of pairs of unrelated commodities are, as expected, stable and small with infrequent periods of uncharacteristic spikes. We hypothesized that these infrequent spurts are associated with sharp expected declines in asset prices associated with the probability of economic downturns and financial leverage (credit stress). The probability of a downturn is likely to be associated with expectations of lower short term interest rates and falling marginal costs of holding inventory (larger convenience yields) which in turn spur simultaneous demand for speculative or anticipatory commodity inventories. Likewise, excessive financial leverage is associated with rising risk of defaults and declining asset values. This is likely to lead to periods of deleveraging and lower economic activity. As a rational response to declining asset prices, risk neutral speculators are likely to shore up commodity inventories in search of arbitrage opportunities as a. We tested this hypothesis by looking at the relationship between pair-wise conditional covariances of the commodity pairs and indicators of uncertainty. The likelihood of recessions and financial leverage were found to be positively related to spurts of joint commodity price movement.

Suggested Citation

  • Mthuli Ncube & Daniel Zerfu Gurara & Dawit B. Tessema, 2014. "Working Paper 205 - Volatility and Co-movement in Commodity Prices- New Evidence," Working Paper Series 2135, African Development Bank.
  • Handle: RePEc:adb:adbwps:2135
    as

    Download full text from publisher

    File URL: https://www.afdb.org/fileadmin/uploads/afdb/Documents/Publications/Working_Paper_205_-_Volatility_and_Co-movement_in_Commodity_Prices-_New_Evidence.pdf
    Download Restriction: no

    References listed on IDEAS

    as
    1. Angus Deaton & Guy Laroque, 1992. "On the Behaviour of Commodity Prices," Review of Economic Studies, Oxford University Press, vol. 59(1), pages 1-23.
    2. Chang, Ting-Huan & Su, Hsin-Mei, 2010. "The substitutive effect of biofuels on fossil fuels in the lower and higher crude oil price periods," Energy, Elsevier, vol. 35(7), pages 2807-2813.
    3. Frankel, Jeffrey A., 2014. "Effects of speculation and interest rates in a “carry trade” model of commodity prices," Journal of International Money and Finance, Elsevier, vol. 42(C), pages 88-112.
    4. Deaton, Angus & Laroque, Guy, 2003. "A model of commodity prices after Sir Arthur Lewis," Journal of Development Economics, Elsevier, vol. 71(2), pages 289-310, August.
    5. Roy van der Weide, 2002. "GO-GARCH: a multivariate generalized orthogonal GARCH model," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 17(5), pages 549-564.
    6. Engle, Robert F. & Kroner, Kenneth F., 1995. "Multivariate Simultaneous Generalized ARCH," Econometric Theory, Cambridge University Press, vol. 11(01), pages 122-150, February.
    7. Harri, Ardian & Nalley, Lanier & Hudson, Darren, 2009. "The Relationship between Oil, Exchange Rates, and Commodity Prices," Journal of Agricultural and Applied Economics, Cambridge University Press, vol. 41(02), pages 501-510, August.
    8. Ron Alquist & Olivier Coibion, 2014. "Commodity Price Co-Movement and Global Economic Activity," Staff Working Papers 14-32, Bank of Canada.
    9. Schwert, G William, 1989. " Why Does Stock Market Volatility Change over Time?," Journal of Finance, American Finance Association, vol. 44(5), pages 1115-1153, December.
    10. Chambers, Robert G. & Lopez, Ramon E., 1984. "A General, Dynamic, Supply-Response Model," Northeastern Journal of Agricultural and Resource Economics, Northeastern Agricultural and Resource Economics Association, vol. 13(2), October.
    11. Deb, Partha & Trivedi, Pravin K & Varangis, Panayotis, 1996. "The Excess Co-movement of Commodity Prices Reconsidered," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 11(3), pages 275-291, May-June.
    12. Paul C. Tetlock, 2007. "Giving Content to Investor Sentiment: The Role of Media in the Stock Market," Journal of Finance, American Finance Association, vol. 62(3), pages 1139-1168, June.
    Full references (including those not matched with items on IDEAS)

    More about this item

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:adb:adbwps:2135. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Adeleke Oluwole Salami). General contact details of provider: http://edirc.repec.org/data/afdbgci.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.