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Price Discovery in Commodity Futures and Cash Markets with Heterogenous Agents

Author

Listed:
  • Sophie van Huellen

    (Department of Economics, SOAS University of London, UK)

Abstract
The paper develops a price discovery model for commodity futures markets that accounts for two forms of limits to arbitrage caused by transaction costs and noise trader risk. Four market regimes are identified: (1) effective arbitrage, (2) transaction costs but no noise trader risk, (3) no transaction costs but noise trader risk and (4) both transaction costs and noise trader risk. It is shown that commodity prices are driven by both market fundamentals and speculative trader positions under the latter two regimes. Further, speculative effects spill over to the cash market under regime (3) but are confined to the futures market under regime (4). The model is empirically tested using data from six grain and soft commodity markets. While regime (4) is rare and short lived, regime (3) with some noise trader risk and varying elasticity of arbitrage prevails.

Suggested Citation

  • Sophie van Huellen, 2018. "Price Discovery in Commodity Futures and Cash Markets with Heterogenous Agents," Working Papers 213, Department of Economics, SOAS University of London, UK.
    • Handle: RePEc:soa:wpaper:213
    as

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    File URL: https://www.soas.ac.uk/sites/default/files/2022-10/economics-wp213.pdf
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    commodity futures; index investment; price discovery; speculation;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q02 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - General - - - Commodity Market
    • Q11 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Agriculture - - - Aggregate Supply and Demand Analysis; Prices

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