"Commodity Price Comovement: The Case of Cotton," with Joseph Janzen, University of California at Davis. Wednesday, November 14, 4:10 PM, 368A Heady Hall.

Joseph Janzen is a Ph.D. candidate in the Department of Agricultural and Resource Economics at the University of California, Davis, where he studies commodity futures markets, agricultural marketing, applied econometrics, and industrial organization. His research assesses the role of speculation, electronic trading, and liquidity constraints in the price discovery process for agricultural commodity futures. Born and raised on a family farm in the Red River Valley of Manitoba, he holds B.Sc. and M.Sc. degrees in agribusiness and agricultural economics from the University of Manitoba.

Abstract: During the commodity price boom and bust of 2007-2008, cotton futures prices rose and fell dramatically in spite of high levels of inventory. At the same time, correlation between cotton and other commodity prices was high. These two observations underlie concerns that cotton prices during this period were poor signals of cotton market fundamentals and that the cotton market was "taken along for a ride" with other commodities. The apparent coincidence of extreme price movement across a broad range of commodities requires an explanation. Were cotton prices driven by the same set of macroeconomic factors as the other commodities? Did cotton markets suffer from supply disruptions at the same time that the other commodities faced disruptions? How did expectations about future market conditions affect prices? What was the role of futures market speculators and the rise of commodity index trading? To answer these questions, we develop and estimate a structural vector autoregression model to test the relative contribution of global economic activity, current and expected supply and demand conditions, and financial speculation to observed cotton prices. To separately identify the impact of current and expected fundamental shocks, we employ a method-of-moments estimator that uses information about the variance of price innovations. We argue that the "kinked" demand curve for storable commodities (due to the zero lower bound on inventories) plausibly creates tranquil and volatile price regimes; the presence of multiple regimes generates additional moment conditions that identify the model. We find that supply and demand shocks specific to the cotton market are the major source of cotton price variation. There is scant evidence of comovement-type effects related to financial speculation. While most historical cotton price spikes are driven by shocks to current net supply, the 2007-2008 spike was caused by higher demand for inventories.