This paper examines the relationship between return volatility and the level ofreturns in commodity markets. We develop a simple commodity price model and showthat the volatility of price changes can be positively or negatively related to demandshocks depending on the demand and supply elasticities. We empirically examine thebehaviour of volatility using both time-series conditional volatility models andhistorical volatility measures for a range of commodities including agricultural products,energy, industrial metals and precious metals. An “inverse leverage effect” – theconditional volatility is higher following a positive shock -- is found in more than halfof the daily spot prices in time-series models. The effect is much weaker in 3-monthfutures market and monthly historical volatility measures. Only crude oil is found toexhibit a “leverage effect” – a higher volatility follows a negative shock, and the reasonis explored in the context of its special market structure.
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