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Explaining the Persistence of Commodity Prices

  • Serena Ng


    (Boston College)

  • Francisco Ruge-Murcia

    (Universite de Montreal)

This paper extends the Competitive Storage Model by incorporating prominent features of the production process and financial markets. A major limitation of this basic model is that it cannot successfully explain the degree of serial correlation observed in actual data. The proposed extensions build on the observation that in order to generate a high degree of price persistence, a model must incorporate features such that agents are willing to hold stocks more often than predicted by the basic model. We therefore allow unique characteristics of the production and trading mechanisms to provide the required incentives. Specifically, the proposed models introduce (i) gestation lags in production with heteroskedastic supply shocks, (ii) multiperiod forward contracts, and (iii) a convenience return to inventory holding. The rational expectations solutions for twelve commodities are numerically solved. Simulations are then employed to assess the effects of the above extensions on the time series properties of commodity prices. Results indicate that each of the features above partially account for the persistence and occasional spikes observed in actual data. Evidence is presented that the precautionary demand for stocks might play a substantial role in the dynamics of commodity prices.

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Paper provided by Boston College Department of Economics in its series Boston College Working Papers in Economics with number 374.

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Length: 25 pages
Date of creation: 01 Apr 1997
Date of revision:
Handle: RePEc:boc:bocoec:374
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  1. Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Development Studies.
  2. Gibson, Rajna & Schwartz, Eduardo S, 1990. " Stochastic Convenience Yield and the Pricing of Oil Contingent Claims," Journal of Finance, American Finance Association, vol. 45(3), pages 959-76, July.
  3. Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
  4. Fama, Eugene F & French, Kenneth R, 1988. " Business Cycles and the Behavior of Metals Prices," Journal of Finance, American Finance Association, vol. 43(5), pages 1075-93, December.
  5. Newbery, David M G & Stiglitz, Joseph E, 1982. "Optimal Commodity Stock-piling Rules," Oxford Economic Papers, Oxford University Press, vol. 34(3), pages 403-27, November.
  6. Pindyck, Robert S, 1993. "The Present Value Model of Rational Commodity Pricing," Economic Journal, Royal Economic Society, vol. 103(418), pages 511-30, May.
  7. Taylor, John B, 1980. "Aggregate Dynamics and Staggered Contracts," Journal of Political Economy, University of Chicago Press, vol. 88(1), pages 1-23, February.
  8. Breeden, Douglas T, 1980. " Consumption Risk in Futures Markets," Journal of Finance, American Finance Association, vol. 35(2), pages 503-20, May.
  9. John B. Taylor & Harald Uhlig, 1989. "Solving Nonlinear Stochastic Growth Models: A Comparison of Alternative Solution Methods," NBER Working Papers 3117, National Bureau of Economic Research, Inc.
  10. Fama, Eugene F & French, Kenneth R, 1987. "Commodity Futures Prices: Some Evidence on Forecast Power, Premiums,and the Theory of Storage," The Journal of Business, University of Chicago Press, vol. 60(1), pages 55-73, January.
  11. Chambers, Marcus J & Bailey, Roy E, 1996. "A Theory of Commodity Price Fluctuations," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 924-57, October.
  12. Bryan R. Routledge & Duane J. Seppi & Chester S. Spatt, 2000. "Equilibrium Forward Curves for Commodities," Journal of Finance, American Finance Association, vol. 55(3), pages 1297-1338, 06.
  13. Deaton, Angus & Laroque, Guy, 1996. "Competitive Storage and Commodity Price Dynamics," Journal of Political Economy, University of Chicago Press, vol. 104(5), pages 896-923, October.
  14. den Haan, Wouter J & Marcet, Albert, 1990. "Solving the Stochastic Growth Model by Parameterizing Expectations," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 31-34, January.
  15. Gustafson, Robert L., 1958. "Carryover levels for grains: A method for determining amounts that are optimal under specified conditions," Technical Bulletins 157231, United States Department of Agriculture, Economic Research Service.
  16. Fischer, Stanley, 1977. "Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule," Journal of Political Economy, University of Chicago Press, vol. 85(1), pages 191-205, February.
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  18. Lester G. Telser, 1958. "Futures Trading and the Storage of Cotton and Wheat," Journal of Political Economy, University of Chicago Press, vol. 66, pages 233.
  19. Taylor, John B, 1979. "Staggered Wage Setting in a Macro Model," American Economic Review, American Economic Association, vol. 69(2), pages 108-13, May.
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  22. Anonymous, 1934. "Price Relations Between May and New-Crop Wheat Futures at Chicago Since 1885," Wheat Studies, Stanford University, Food Research Institute, issue 05, February.
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