Since 2004, commodity futures markets have seen an unprecedented liquidity inflow linked to noise traders that follow global liquidity cycles rather than market fundamentals. This paper develops a price discovery model for commodity futures markets that incorporates noise trader effects by assuming two forms of limits to arbitrage: transaction costs and noise trader risk. It is shown that under these assumptions, commodity prices are driven by both market fundamentals and noise trader positions. Further, noise trader effects spill over to the cash market if limits to arbitrage due to transaction costs are imperfect but are confined to the futures market otherwise. The model is empirically tested using data from six grain and soft commodity markets.
|Number of pages||13|
|Journal||Journal of International Money and Finance|
|Publication status||Published - Jul 2019|
- Commodity futures
- Index investment
- Price discovery
Research Beacons, Institutes and Platforms
- Global Development Institute
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