Economic Uncertainty and Commodity Futures Volatility

Abstract

This paper investigates the dynamics of commodity futures volatility. I derive the variance decomposition for the commodity futures basis to show how unexpected excess returns result from new information about the expected future interest rates, convenience yields, and risk premia. This motivates my empirical analysis of the volatility impact of economic and ination regimes and commodity supply-demand shocks. Using data on major commodity futures markets and global bilateral commodity trade, I analyze the extent to which commodity volatility is related to fundamental uncertainty from increased emerging market demand and macroeconomic forecast uncertainty, while controlling for the potential impact of nancial frictions introduced by changing market structure and commodity index trading. Higher concentration in emerging market importers of a commodity is associated with higher futures volatility. I nd commodity futures volatility is signicantly predictable using variables capturing macroeconomic uncertainty. I examine the conditional variation in the asymmetric relationship between returns and volatility, and how this relates to the futures basis and sensitivity to consumer and producer shocks.