Short-term price volatility and reversion rate in mineral commodity markets
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ORIGINAL PAPER
Short-term price volatility and reversion rate in mineral commodity markets Diego García 1 & Juan Ignacio Guzmán 2 Received: 8 January 2019 / Accepted: 9 May 2019 # Springer-Verlag GmbH Germany, part of Springer Nature 2019
Abstract The commodity price volatility is a critical characteristic of mineral markets, since it has planning as well as financial implications for different market participants such as governments, producers, investors, and consumers. This paper inquiries into the price volatility of mineral commodity markets by filling the gap between two main explanations available in the economic literature: the view of mineral economists, who establish that short-term price volatility arises mainly because in this time horizon supply cannot adjust to demand (which is associated with a very small speed of adjustment to market equilibrium), and the view of neoclassic microeconomic theorists, who affirm that supply adjusts instantly to demand (which is related with a high speed of adjustment to market equilibrium). We developed a conceptual model based on the current understanding of mineral economics, but where time to adjust to equilibrium plays a significant role into setting prices. Based on this, we posit that mineral commodity markets with larger reversion rates (i.e., the time necessary to achieve a long-term equilibrium price) have a smaller price volatility. By using a crosssectional econometric model for 50 mineral commodities in the period 1900–2015, we found statistical support for an inverse relationship between short-term price volatility and reversion rates, which supports our hypothesis. Keywords Short-term price volatility . Commodity markets . Reversion rate . Market equilibrium . Price equilibrium . Disequilibrium JEL Classifications D40 . Q31
Introduction Prices of many mineral commodities fluctuate greatly over the short-term (Tilton and Guzmán 2016). As a matter of fact, it is not unusual for prices to double or fall by half within a year or two. Rapid, unexpected and, often, large movements in commodity prices are an important feature of their behavior (Cashing and McDermott 2002). As Brunetti and Gilbert (1995) indicate, this phenomenon—called price volatility—
measures how much a price changes either about its longterm level or about a long-term trend. Price volatility measures the variation on prices typically over a day to day, week to week, month to month, or year to year frequency. Following the standard literature (see, for example, Brunetti and Gilbert 1995), it can be computed as the standard deviation of logarithm of prices on a sample over a period. Mathematically: σ¼
* Juan Ignacio Guzmán [email protected] Diego García [email protected] 1
Departamento de Industrias, Universidad Técnica Federico Santa María, Av. España, 1680 Valparaíso, Chile
2
Departamento de Ingeniería de Minería, Pontificia Universidad Católica de Chile, Vicuña Mackenna, 4860 Santiago, Chile
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