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Price transmission and effects of exchange rates on domestic commodity prices via offshore and currency hedging

Price transmission and effects of exchange rates on domestic commodity prices via offshore and currency hedging
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.
278
University of Dundee
Tantisantiwong, Nongnuch
73b57288-a4dc-4456-8d1b-12b8d07dc3b4
Tantisantiwong, Nongnuch
73b57288-a4dc-4456-8d1b-12b8d07dc3b4

Tantisantiwong, Nongnuch (2013) Price transmission and effects of exchange rates on domestic commodity prices via offshore and currency hedging (Dundee Discussion Papers in Economics, 278) Dundee. University of Dundee

Record type: Monograph (Discussion Paper)

Abstract

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.

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More information

Published date: 1 October 2013
Organisations: Centre for Digital, Interactive & Data Driven Marketing, Banking & Finance

Identifiers

Local EPrints ID: 369325
URI: https://eprints.soton.ac.uk/id/eprint/369325
PURE UUID: 281f6395-b975-44b6-a0d2-30a3da5c3357

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Date deposited: 01 Oct 2014 10:54
Last modified: 13 Mar 2019 18:23

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