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First and Second Order Impacts of Speculation on Commodity Price Volatility

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  • Doroudian, Ali
  • Vercammen, James

Abstract

This paper contributes to the debate on the link between speculation and price volatility in two ways. First, a simple CAPM model is used to derive the demand for commodity futures contracts by institutional investors, and this derived demand is then integrated into a simple rational expectations model of a commodity market with a demand for hedging by merchants. Second, a GARCH model is used to measure volatility in the U.S. rice market before and after the introduction of a futures contract for rice in 1994. The theoretical and empirical analysis both demonstrate that speculation results in a first order decrease in commodity price volatility, but part of this decrease will be offset by second order pricing distortions that are caused by institutional speculators.

Suggested Citation

  • Doroudian, Ali & Vercammen, James, 2012. "First and Second Order Impacts of Speculation on Commodity Price Volatility," Working Papers 126947, Structure and Performance of Agriculture and Agri-products Industry (SPAA).
    • Handle: RePEc:ags:spaawp:126947
    DOI: 10.22004/ag.econ.126947
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    References listed on IDEAS

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    1. Sanford Grossman, 1989. "The Informational Role of Prices," MIT Press Books, The MIT Press, edition 1, volume 1, number 0262572141, December.
    2. Christopher L. Gilbert, 2010. "How to Understand High Food Prices," Journal of Agricultural Economics, Wiley Blackwell, vol. 61(2), pages 398-425, June.
    3. Cox, Charles C, 1976. "Futures Trading and Market Information," Journal of Political Economy, University of Chicago Press, vol. 84(6), pages 1215-1237, December.
    4. Carter, Colin A., 1999. "Commodity futures markets: a survey," Australian Journal of Agricultural and Resource Economics, Australian Agricultural and Resource Economics Society, vol. 43(2), pages 1-39, June.
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    Cited by:

    1. Ederer, Stefan & Heumesser, Christine & Staritz, Cornelia, 2013. "The role of fundamentals and financialisation in recent commodity price developments: An empirical analysis for wheat, coffee, cotton, and oil," Working Papers 42, Austrian Foundation for Development Research (ÖFSE).
    2. Stefan Ederer & Christine Heumesser & Cornelia Staritz, 2016. "Financialization and commodity prices -- an empirical analysis for coffee, cotton, wheat and oil," International Review of Applied Economics, Taylor & Francis Journals, vol. 30(4), pages 462-487, July.

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