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Futures trading and the excess comovement of commodity prices

  • Yannick Le Pen
  • Benoît Sévi

We empirically reinvestigate the issue of excess comovement of commodity prices initially raised in Pindyck and Rotemberg (1990) and show that excess comovement, when it exists, can be related to hedging pressure and speculative intensity in commodity futures markets. Excess comovement appears when commodity prices remain correlated even after adjusting for the impact of common factors. While Pindyck and Rotemberg and following contributions examine this issue using a relevant but arbitrary set of control variables, we use recent developments in large approximate factor models so that a richer information set can be considered and “fundamentals” are likely to be adequately modeled. We consider a set of 8 unrelated commodities along with 187 real and nominal macroeconomic variables from which 9 factors are extracted over the period 1993-2010. Our estimates provide evidence of a time-varying excess comovementwhich is only occasionally significant, even after controlling for heteroscedasticity. Interestingly, excess comovement is mostly significant in recent years when a large increase in the trading of commodities is observed and also in crisis periods. However, we show that this increase in trading activity alone has no explanatory power for the excess comovement. Conversely, measures of hedging and speculative activity explain around 50% of the estimated excess comovement thereby showing the strong impact of the financialization process, and more generally the significant influence of the behavior of some categories of traders.

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Paper provided by Department of Research, Ipag Business School in its series Working Papers with number 2013-019.

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Length: 56 pages
Date of creation: 02 Jul 2013
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Handle: RePEc:ipg:wpaper:2013-019
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