Working Paper: NBER ID: w16875
Authors: Viral V. Acharya; Lars A. Lochstoer; Tarun Ramadorai
Abstract: Motivated by the literature on limits-to-arbitrage, we build an equilibrium model of commodity markets in which speculators are capital constrained, and commodity producers have hedging demands for commodity futures. Increases (decreases) in producers' hedging demand (speculators' risk-capacity) increase hedging costs via price-pressure on futures, reduce producers' inventory holdings, and thus spot prices. Consistent with our model, producers' default risk forecasts futures returns, spot prices, and inventories in oil and gas market data from 1980-2006, and the component of the commodity futures risk premium associated with producer hedging demand rises when speculative activity reduces. We conclude that limits to financial arbitrage generate limits to hedging by producers, and affect both asset and goods prices.
Keywords: arbitrage; hedging; commodity markets; financial frictions
JEL Codes: G12; G13; G24; G33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Increase in commodity producer default risk (Q02) | Increase in aggregate and individual producer hedging demand (Q11) |
| Increase in commodity producer default risk (Q02) | Increase in futures risk premium (G13) |
| Higher default risk (G32) | Increase in excess returns on short-term futures (G19) |
| Higher conditional volatility of commodity prices (Q02) | Greater fraction of futures risk premium attributable to producer default risk (G13) |
| Limits to financial arbitrage (G19) | Limits on hedging by producers (G13) |
| Limits on hedging by producers (G13) | Effects on asset prices and real economic variables (E44) |