Commodity Price Volatility

In this paper, Dr Mu and his co-author Dr Yu-Fu Chen from Business School, University of Dundee, developed a commodity pricing model and show that commodity price volatility can be positively or negatively related to demand shocks depending on the demand and supply elasticities. Empirically, Dr Mu studies the return-volatility relationship in 19 commodities including agriculture, energy, industrial metals and precious metals. The volatility is found to be higher following positive price shocks in more than half of the daily spot prices. This positive relationship between return and demand is weaker in the three-month futures market, the period after mid-2000s and monthly historical volatility measures. The study provides support for the notion of financialization of commodities since mid-2000s.

In spot markets, only crude oil exhibits a different pattern in which higher volatility follows a negative shock. The reason is explored in the context of its special market structure in which low cost producers, such as OPEC or OPEC plus, have significant influence on market. This theory helps explain the observed price volatility in the current crude oil market.

Speaking about the significance of the study, Dr Mu points out that understanding the dynamics of commodity price volatility is important for financial and risk management decisions in energy and resource industries. Volatility is also a crucial parameter for pricing financial derivatives such as options and swaps. So the study not only advances our understanding in this area but also has direct real world implications.