Short-term price volatility and reversion rate in mineral commodity markets

Abstract

The commodity price volatility is a critical characteristic of mineral markets, since it has planning as well as financial implications for different market participants such as governments, producers, investors, and consumers. This paper inquiries into the price volatility of mineral commodity markets by filling the gap between two main explanations available in the economic literature: the view of mineral economists, who establish that short-term price volatility arises mainly because in this time horizon supply cannot adjust to demand (which is associated with a very small speed of adjustment to market equilibrium), and the view of neoclassic microeconomic theorists, who affirm that supply adjusts instantly to demand (which is related with a high speed of adjustment to market equilibrium). We developed a conceptual model based on the current understanding of mineral economics, but where time to adjust to equilibrium plays a significant role into setting prices. Based on this, we posit that mineral commodity markets with larger reversion rates (i.e., the time necessary to achieve a long-term equilibrium price) have a smaller price volatility. By using a cross-sectional econometric model for 50 mineral commodities in the period 1900–2015, we found statistical support for an inverse relationship between short-term price volatility and reversion rates, which supports our hypothesis.