Price Transmission and Effects of Exchange Rates on Domestic Commodity Prices via Offshore and Currency Hedging

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.

Estimating the Price of ROCs

The UK government introduced the Renewable Obligation (RO), a system of tradable quotas, to encourage the installation of renewable electricity capacity. Each unit of generation from renewables created a renewable obligation certificate (ROC). Electricity generators must either; earn ROCs through their own production, purchase ROCs in the market or pay the buy-out price to comply with the quota set by the RO. A unique aspect of this regulation is that all entities holding ROCs receive a share of the buy-out fund (the sum of all compliance purchases using the buy-out price). This set-up ensures that the difference between the market price for ROCs and the buy-out price should equal the expected share of the buy-out fund, as regulated entities arbitrage these two compliance options. The expected share of the buy-out fund depends on whether enough renewable generation is available to meet the quota. This analysis tests whether variables associated with renewable generation or electricity demand are correlated with, and thus can help predict, the price of ROCs.

Fractional Integration of the Price-Dividend Ratio in a Present-Value Model of Stock Prices

We re-examine the dynamics of returns and dividend growth within the present-value framework of stock prices. We find that the finite sample order of integration of returns is approximately equal to the order of integration of the first-differenced price-dividend ratio. As such, the traditional return forecasting regressions based on the price-dividend ratio are invalid. Moreover, the nonstationary long memory behaviour of the price-dividend ratio induces antipersistence in returns. This suggests that expected returns should be modelled as an AFIRMA process and we show this improves the forecast ability of the present-value model in-sample and out-of-sample.