Dundee Discussion Papers in Economics 278: Price transmission and effects of exchange rates on domestic commodity prices via offshore and currency hedging

Nongnuch Tantisantiwong

    Research output: Working paperDiscussion paper

    Abstract

    The framework presents how trading in the foreign commodity futures market and the forward exchange market can affect the optimal spot positions of domestic commodity producers and traders. It generalizes the models of Kawai and Zilcha (1986) and Kofman and Viaene (1991) to allow both intermediate and final commodities to be traded in the international and futures markets, and the exporters/importers to face production shock, domestic factor costs and a random price. Applying mean-variance expected utility, we find that a rise in the expected exchange rate can raise both supply
    and demand for commodities and reduce domestic prices if the exchange rate elasticity of supply is greater than that of demand. Whether higher volatilities of exchange rate and foreign futures price can reduce the optimal spot position of domestic traders depends on the correlation between the exchange rate and the foreign futures price. Even though the forward exchange market is unbiased, and there is no correlation between commodity prices and exchange rates, the exchange rate can still affect domestic trading and prices through offshore hedging and international trade if the traders are interested in their profit in domestic currency. It illustrates how the world prices and foreign futures
    prices of commodities and their volatility can be transmitted to the domestic market as well as the
    dynamic relationship between intermediate and final goods prices. The equilibrium prices depends on
    trader behaviour i.e. who trades or does not trade in the foreign commodity futures and domestic forward currency markets. The empirical result applying a two-stage-least-squares approach to Thai rice and rubber prices supports the theoretical result.
    Original languageEnglish
    PublisherUniversity of Dundee
    Number of pages38
    Publication statusPublished - Oct 2013

    Publication series

    NameDundee Discussion Papers in Economics
    PublisherUniversity of Dundee
    No.278
    ISSN (Print)1473-236X

    Keywords

    • commodity markets
    • offshore hedging
    • currency hedging
    • asset pricing
    • price transmission

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