Agricultural price volatility and speculation by commodity index funds: a theoretical analysis

The role that speculation in futures markets plays during food price spikes is a subject of lively dispute. This issue is often addressed with empirical analyses. They suffer from data limitations and focus on the short-term impacts. The paper aims to discuss these issues.

The authors develop a theoretical model to explain the behaviour of speculators and producers in futures and cash markets. Compared to the only two theoretical analyses by Vercammen and Doroudian where informational externalities are excluded and by Fishe et al. where production responses are excluded, the authors introduce both informational externalities and lagged production responses.

The authors find that the expanded net long positions of commodity index funds (CIF) are inconsistent with lower stock levels that typically prevail before the price spikes. These positions stimulate production, hence stocks, before the price spikes. Thus they contribute to soften the price volatility.

The simulation results indicate that before imposing new regulations on financial markets, such as position limits on index funds, their beneficial medium-term effect as a hedging instrument for commercial participants should not be omitted or underestimated.

Because the authors develop a second-best theoretical framework, the authors find that CIF are not a systematic cause of medium-term market swings.