Academic journal article Monthly Labor Review

Commodity Price Volatility: Trends during 1975-84

Academic journal article Monthly Labor Review

Commodity Price Volatility: Trends during 1975-84

Article excerpt

Commodity price volatility: trends during 1975-84

It has long been observed that commodity prices exhibit wide ranges of variability. Some prices persistently fluctuate sharply from month to month because of special supply or demand factors (or both) relating to respective commodity markets. In such cases, supply and demand are said to be "price inelastic,' meaning that a small shift in supply or in demand results in a large price change. This occurs most frequently in competitive markets for goods which have only limited substitutes. For example, agricultural products and their derivatives are subject to sharp price changes because of the influence of weather on production and marketing. Demand (and hence prices) for basic materials traded internationally may change rapidly because of exchange rate movements, political turmoil, or large purchases by governments.

These are the primary factors which have been cited as causing commodity price instability. (Note that we are discussing microeconomic factors relating to particular products, not macroeconomic factors.) It is believed that these factors affect certain commodities more than others. Likewise, the volatility of price for these commodities is generally regarded as persistent.

We intend to test these widely held beliefs by analyzing short-term price movements for a broad range of goods over a 10-year period. A judgmental sample of 156 Producer Price Indexes for commodity groupings was chosen for this purpose.1 For each index series, monthly percent changes were computed from January 1975 to December 1984 (seasonally adjusted data were used if available between 1979 and 1984). Data were excluded for the pre-1975 period, which was marked by a series of major grain-and oil-related "shocks.'2

Measurement methods

Our choice of a mathematical tool to measure volatility depends on how we define volatility. If the definition "noting or subject to constant or sharp fluctuation'3 is used, a logical measure would be the mean of the absolute values of the monthly percent changes. Because this measure implicitly assumes a flat price level as a reference standard, we call it the "static volatility index' in this article.

In the context of substantial inflation, however, prices for most goods will show a persistent upward trend. In such a case, the static volatility index is biased because it inappropriately counts the more-or-less regular price increases as though they were irregular deviations. To distinguish the trend of a time series from the truly random movements that characterize its volatility per se, we need to modify the above definition to read: "noting or subject to constant or sharp fluctuations that are serially independent.'

Accordingly, we will place primary emphasis on an alternative measure of volatility, namely, the standard deviation of the monthly percent changes. This measure focuses on the variability of the rate of price changes, as opposed to the variability of the price level. We call this measure the "dynamic volatility index' to indicate that its magnitude is not affected by any underlying trend in the time series. The dynamic index will be used for making ordinal comparisons between commodities. The static volatility index, although flawed, does convey useful information and plays a subsidiary role in the analysis. The absolute or cardinal magnitude of the static index carries more meaning than does that of the dynamic index; the static index value may be used to judge the significance of a given monthly change for a particular commodity in a historical context.

To produce objective indices of price volatility, the values of the commodities were combined to yield unweighted averages (that is, each commodity counts the same) for various Producer Price Index stage-of-processing categories. There were two major issues to resolve: Which types of commodities tend to be most volatile and what are their patterns of volatility? …

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