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Commodity Markets: Rational Expectations in Markets With Irrational Investors

Author

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  • Wong, Teddy T.
  • Smith, Aaron D.

Abstract

The "financialization" of commodity markets have become a concern for policy makers and market participants. What was once a market for the hedging of holding physical commodities has expanded to become a market for the diversification of financial assets. When financial assets diversification goals are decoupled from the fundamental factors that affect producers and consumers of physical goods futures markets may not be as efficient in aggregating information concerning the economics of the underlying commodity. Theoretical understanding of whether commodity futures market function well under exogenous shifts in demand for futures contracts depend on our assumptions of how market participants behave, including their level of risk aversion. This paper builds a competitive storage model with an explicit futures market that incorporates irrational shocks to demand for futures contracts. This model is flexible enough to investigate the impact of the "financialization" of commodity futures markets and the resulting impacts.

Suggested Citation

  • Wong, Teddy T. & Smith, Aaron D., 2010. "Commodity Markets: Rational Expectations in Markets With Irrational Investors," 2010 Annual Meeting, July 25-27, 2010, Denver, Colorado 61526, Agricultural and Applied Economics Association.
    • Handle: RePEc:ags:aaea10:61526
    DOI: 10.22004/ag.econ.61526
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    References listed on IDEAS

    as
    1. Angus Deaton & Guy Laroque, 1992. "On the Behaviour of Commodity Prices," The Review of Economic Studies, Review of Economic Studies Ltd, vol. 59(1), pages 1-23.
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