Commodity Market Dynamics and Price Volatility: Insights from Dynamic Storage Models

Abstract

The recent fluctuations of agricultural commodity prices have stimulated the debate on the potential causes of price volatility. The most common explanation is that weather shocks or other external factors perturb supply, thus leading to substantial price fluctuations. In view of the development of global markets, which tend to average out supply disturbances, one would expect price volatility to decrease if primarily caused by external shocks. This however is contradicted by the experience of the recent past. An alternative explanation proposes that the persistent fluctuations are the result of nonlinear dynamics and would even occur in the absence of external shocks. The focus of this paper is on the latter type of explanation. It is investigated under which conditions price volatility is primarily caused by nonlinear dynamics. A system dynamics modelling approach is used for the analysis. The model results show that plausible behaviour of actors can lead to persistent price fluctuations, even in the absence of external shocks.