American Journal of Agricultural Economics, 100(1):264-285, Oxford University Press, 2018. Paper abstract bibtex
Recent booms and busts in commodity prices have generated concerns that financial speculation causes excessive commodity‐price comovement, driving prices away from levels implied by supply and demand under rational expectations. We develop a structural vector autoregression model of a commodity futures market and use it to explain two recent spikes in cotton prices. In doing so, we make two contributions to the literature on commodity price dynamics. First, we estimate the extent to which cotton price booms and busts can be attributed to comovement with other commodities. Finding such comovement would be necessary but would not be sufficient evidence to establish that broad‐based financial speculation drives commodity prices. Second, after controlling for aggregate demand and comovement, we develop a new method to point identify shocks to precautionary demand for cotton separately from shocks to current supply and demand. To do so, we use differences in volatility across time implied by the rational expectations competitive storage model. We find limited evidence that financial speculation caused cotton prices to spike in 2008 or 2011. We conclude that the 2008 price spike was driven mostly by precautionary demand for cotton, and the 2011 spike was caused by a net supply shortfall.