Fast & furious: Do psychological and legal factors affect commodity price volatility?

Abstract

AbstractThe present study explores to what extent policy insecurity and the changes in the US legal financial infrastructure have affected commodity price volatility. In addition to macroeconomic fundamentals, the study introduces two ‘psychological’ factors proxied by the economic policy uncertainty index and the perception of price risk within specific commodity markets, plus an institutional (de)regulatory factor constructed as a dichotomous variable. The latter mirrors the period of financial deregulation experienced under the Commodity Futures Modernization Act and the period of regulation registered under the Dodd‐Frank Act. The results reveal that price volatility is a complex phenomenon generated by the joint effect of a plethora of drivers. Both economic policy uncertainty and highly deregulated financial markets exert an influence on price dynamics and produce higher price volatility. Similarly, higher market risk perception leads to higher price fluctuations. Exchange rate, financial wealth and crude oil further explain price rises and falls. The study indicates that government decisions influence commodity markets and a financial system grounded on a sound legal basis is essential for its orderly functioning. A transparent financial structure should be able to generate checks and balances for the market, spawn vibrant policies and prevent the negative consequences of intense price volatility.