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Title: Limits to Arbitrage and Hedging: Evidence from Commodity Markets
Authors: Acharya, Viral
Lochstoer, Lars
Ramadorai, Tarun
Issue Date: 21-Jan-2010
Series/Report no.: FIN-09-035
Abstract: Motivated by the literature on limits-to-arbitrage, we build an equilibrium model of commodity markets in which speculators are capital constrained, and commodity producers have hedging demands for commodity futures. Increases (decreases) in producers' hedging demand (speculators' risk capacity) increase hedging costs via price-pressure on futures, reduce producers' inventory holdings, and thus spot prices. Consistent with our model, producers' default risk forecasts futures returns,spot prices, and inventories in oil and gas market data from 1980-2006, and the component of the commodity futures risk premium associated with producer hedging demand rises when speculative activity reduces. We conclude that limits to financial arbitrage generate limits to hedging by producers, and affect both asset and goods prices.
URI: http://hdl.handle.net/2451/29543
Appears in Collections:Finance Working Papers

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