Heterogeneity and Correlation-Volatility of Commodities and Stock: Theory and Estimation

Project: Research

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The stability of commodities prices has profound economic and political implications. The dramatic boom/bust of commodity prices in the past decade has fostered a belief among policymakers and market observers that excessive speculation in commodity futures is a major cause for the dramatic changes in commodity prices. With the rise of commodity prices, we observe a huge inflow of funds invested in commodity futures by the institutional investors. Several influential empirical studies, such as Singleton (2014) and Tang and Xiong (2012), support this hypothesis. Other empirical studies, such as Hamilton and Wu (2015) and Janzen, Smith and Carter (2018), have found that this hypothesis has little support in the data. This highlights the difficulty in addressing this question in a purely empirical exercise or a partial equilibrium framework. On the other hand, a deeper question would be what are the determinant factors that drive the dynamics of commodity and commodity futures prices.We intend to address this question in a full equilibrium model. Households in our model are both investors and speculators due to their different beliefs or models to interpret public information. Also, they also have different time discount rates. Thus, the dynamics of asset prices, including commodity and commodity futures prices, are driven by beliefs and wealth distribution of households. Our model yields closed-form solutions for prices, including stock, commodities and commodity futures, and bonds, and their dynamics. This enables us to take the model to the data with full cross-sectional asset prices of all the three asset classes. This should yield deeper economic insights into the behavior of asset prices.Specifically, our model prices and their return variance-covariance are directly linked to preference parameters and beliefs and hence enable us to study and understand the time-varying comovements among equity, commodity prices. The excess comovement among commodities is a long-standing puzzle in the literature, as documented in Pindyck and Rotemberg (1990). The equity-commodity and commodity-commodity correlations increase dramatically and are time-varying as documented in Tang and Xiong (2012). Our project will shed light on the driving forces behind these time-varying comovements and volatilities.


Project number9042840
Grant typeGRF
Effective start/end date1/01/20 → …