Understanding World Commodity Prices: Returns, Volatility and Diversification

Abstract

In recent times, the prices of internationally-traded commodities have reached record highs and are expected to continue growing in the foreseeable future. This phenomenon is partially driven by strong demand from a small number of emerging economies, such as China and India. This paper places the recent commodity price boom in historical context, drawing on an investigation of the long-term time-series properties, and presents unique features for 33 individual commodity prices. Using a new methodology for examining cross-sectional variation of commodity returns and its components, we find strong evidence that the prices of world primary commodities are extremely volatile. In addition, prices are roughly 30 percent more volatile under floating than under fixed exchange rate regimes. Finally, using the capital asset pricing model as a loose framework, we find that global macroeconomic risk components have become relatively more important in explaining commodity price volatility.