Commodity futures price volatility, convenience yield and economic fundamentals

Abstract

Commodity price volatility increased during 2006 to 2011 first with the commodity bull cycle of 2006 to 2008 and then with the credit freeze crisis and Great Recession. This letter uses both high- and low-frequency data over 1990 to 2011 to examine the link between economic fundamentals and measures of realized volatility and convenience yield computed from estimated futures price forward curves. The possible influence of institutional investors (index traders) is also examined. Affine term structure models are estimated using Intercontinental Exchange (ICE) futures prices on cotton, a commodity for which economic fundamentals can be readily identified and measured. The results, robust across specifications, suggest that the determinants of volatility, but not convenience yield, changed during the period 2006 to 2011. There is no evidence that index traders are responsible for increased volatility or changes in convenience yield.

Keywords:

• volatility
• futures markets
• theory of storage
• convenience yield
• macroeconomic fundamentals
• Commitment of Traders
• index traders

Acknowledgments

Power acknowledges funding support Hatch project RI-9262, the Social Science and Humanities Research Council of Canada (SSHRC), the Institut de Finance Mathématique de Montréal (IFM2), and Centre Inter-universitaire sur le Risque, les Politiques Économiques et l'Emploi (CIRPÉE).

Notes

¹ Details for this first-step estimation are omitted to conserve space but are available upon request.

²Details for this first-step estimation are omitted to conserve space but are available upon request.