Commodity Price Comovement: The Case of Cotton

Joseph P. Janzen, Aaron D. Smith

Research output: Contribution to conferencePaperpeer-review

Abstract

During the commodity price boom and bust of 2007-2008, cotton futures prices rose and fell dramatically in spite of high levels of inventory. At the same time, correlation between cotton and other commodity prices reached historically high levels. These two observations underlie concerns that cotton prices during this period were poor signals of cotton market fundamentals and that the cotton market was ’taken along for a ride’ with other commodities. The apparent coincidence of extreme price movement across a broad range of commodities requires an explanation. Were cotton prices driven by the same set of macroeconomic factors as the other commodities? Did cotton markets suffer from supply disruptions at the same time that the other commodities faced disruptions? What was the role of futures market speculators and the rise of commodity index trading? br br Economists have been writing about excessive or unexplained comovement among commodity prices since at least Pindyck and Rotemberg (1990). Using this literature as a starting point, we identify potential explanations for commodity price comovement. Past studies have accounted for macroeconomic activity, and cotton-specific supply and demand changes. Tang and Xiong (2010) suggest that speculative pressure due to broad-based commodity index trading may also cause comovement among commodity prices. We develop and estimate a structural vector autoregression model to test the relative contribution of these effects to observed cotton prices. We find that supply shocks to current net supply, the 2007-2008 spike was caused by higher demand for inventories.
Original languageEnglish (US)
DOIs
StatePublished - 2012
Externally publishedYes

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