Futures Price Volatility in Commodities Markets: The Role of Short Term vs Long Term Speculation

Abstract

Futures price volatility in commodities markets:The role of short term vs long term speculation Abstract: This paper evaluates how different types of speculation affect the volatility of commodities' futures prices. We adopt four indexes of speculation: Working's T, the market share of non-commercial traders, the percentage of net long speculators over total open interest in future markets, which proxy for long term speculation, and scalping, which proxies for short term speculation. We consider four energy commodities (light sweet crude oil, heating oil, gasoline and natural gas) and seven non-energy commodities (cocoa, coffee, corn, oats, soybean oil, soybeans and wheat) over the period 1986-2010 analyzed at weekly frequency. Using GARCH models we find that speculation significantly affects volatility of returns: short term speculation has a positive and significant impact on volatility, while long term speculation generally has a negative effect. The robustness exercise shows that: i) scalping is positive and significant also at higher and lower data frequencies; ii) results remain unchanged through different model specifications (GARCH-in-mean, EGARCH, and TARCH); iii) results are robust to different specifications of the mean equation.JEL Codes: C32; G13; Q11; Q43.

Return dynamics during periods of high speculation in a thinly traded commodity market

“…Our results imply that speculation does contribute to greater uncertainty in the market regarding short‐term return developments in the form of volatility clusters. This is in line with earlier findings of Streeter and Tomek () and Manera et al (), who also find that the speculation ratio is a driver of volatility. However, as implied by the insignificant estimates for the speculation parameters in the mean equation, these effects only pertain to the short term, beyond which speculators do not appear to alter return dynamics.…”

“…Other measures of speculative activity, which have, for example, been used in Manera et al (, ), are the long‐only, the short‐only, and the net‐long share of speculators. We denote these three shares by and define them as and For each of these alternative speculation measures, we construct the regime dummy series of high‐speculation regimes analogously to the method described above and repeat the main regression accordingly.…”

“…Manera, Nicolini, and Vignati () find that in nine fuel and agricultural commodity markets, the impact of speculation, as measured by Working's () T , on returns is either not statistically significant or significantly negative. Further studies by Manera, Nicolini, and Vignati (, ) show that in different fuel and agricultural markets, various speculation measures based on weekly CFTC trader position data also have a significantly negative impact on the volatility of futures returns. This implies that speculation exerts, contrary to public opinion, a stabilizing effect on commodity returns.…”

“…Conversely, when measuring speculation using the speculation ratio of Garcia, Leuthold, and Zapata (), which divides trading volume by open interest, Manera et al () find a positive impact of speculation on return volatility. This finding is in line with earlier results of Streeter and Tomek () and Du, Yu, and Hayes (), who also use the speculation ratio to measure the impact that speculators have on volatility in the markets for soybeans and crude oil, respectively.…”

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“…Discussing several empirical also justify that investments of agricultural futures exchange are one of the factors contributing to the permanent increase in food price volatility (Gilbert 2010, Robles et al, 2009Boonyanuphong and Sriboonchitta, 2014). Manera et al (2013) used GARCH models and found that speculation significantly affected the volatility of returns. Manera et al (2013) further explained that short term speculation would cause a positive impact while long term speculation generally gave an negative effect significant on volatility for energy products (such as crude oil, heating oil, gasoline, and natural gas) and non-energy commodities such as cocoa, coffee, corn, oats, soybean oil, soybeans, and wheat over the period of 1986-2011.…”