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INTEREST RATES AND THE VOLATILITY AND CORRELATION OF COMMODITY PRICES

Published online by Cambridge University Press:  09 November 2016

Joseph W. Gruber  and
Robert J. Vigfusson
Joseph W. Gruber
Affiliation:
Board of Governors of the Federal Reserve System
Robert J. Vigfusson*
Affiliation:
Board of Governors of the Federal Reserve System
*
Address correspondence to: Robert Vigfusson, Board of Governors of the Federal Reserve System, Washington, DC 20551, USA; e-mail: robert.vigfusson@frb.gov.
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Abstract

We propose a novel explanation for the observed increase in the correlation of commodity prices over the past decade. In contrast to theories that rely on the increased influence of financial speculators, we examine the effect of interest rates on the volatility and correlation of commodity prices via a panel GARCH model. In theory, lower interest rates decrease the volatility of prices, as lower inventory costs promote the smoothing of transient shocks, and increase price correlation if common shocks are more persistent than idiosyncratic shocks. Empirically, we find that price volatility attributable to transitory shocks declines with interest rates, whereas particularly for metals prices, price correlation increases as interest rates decline.

Keywords

Commodity StoragePanel GARCHDynamic Factor Model

Information

Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Special Issue 3: Dynamics of Oil and Commodities Prices , April 2018 , pp. 600 - 619
Copyright
Copyright © Cambridge University Press 2016 

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Footnotes

The views in this paper are solely the responsibility of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System. We thank Ron Alquist for helpful comments as well as those of an anonymous referee. Nathan Dau-Schmidt and Keith Munz provided superb research assistance.

References

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