Does futures speculation stabilize spot prices? Evidence from metals markets

Abstract

An attempt is made to test empirically the hypothesis that increased speculation in futures markets stabilizes spot price volatility in metals markets. This is confirmed not by an ad hoc volatility ratio test but by generalizing the framework of Driskill et al. (Driskill, R., McCafferty, S. and Sheffrin, S., 1991. Speculative intensity and spot futures price variability, Economic Inquiry, 29, 737-751) and Kawai (Kawai, M. 1983. Price volatility of storable commodities under rational expectations in spot and futures markets, International Economic Review, 24, 1313-1317). The hypothesis is tested using a critical condition generated by the model: the test is based on data from the copper, gold, silver and aluminium markets. The significance of the estimated coefficients is analysed by Monte Carlo methods. The empirical results, which are based on these four metals markets for the period 1980–1990, reject the hypothesis that an increase in the intensity of futures speculation tends to decrease the spot price volatility, and thus stabilizes spot markets.