Doctor of Philosophy Topic Proposal Presentation Micro-Structure of Futures Prices: Convenience Yield and Open Positions Data as Source for Predicting Inflation and Inflation Targeting Based Monetary Policy in G7 Countries Submitted to: Open University November 15th, 2012
Introduction • Mercantalist economies and commodity driven markets. – Rising world population. (80 Million per year) – Scarce Resources. – New Consumers (China, India) – Fall of paper assets and economic confidance and the financial crisis. Submitted By: Okan 2 Aybar, ETU20111319
Introduction (continued) • Monetary policy methods. – Price Level Targeting – Monetary Aggregates – Fixed Exchange Rates – Gold Standard – Mixed Policies – Inflation Targeting Claim Paper Inflation targeting as a monetary policy framework that Masson et al. (1997) contains a specific target of future inflation and adjust all available monetary tools to accomplish this objective regardless of what happens in other sectors of financial and economic structure. Submitted By: Okan 3 Aybar, ETU20111319
The Rise of Inflation Targeting Claim Paper Monetary policy can be achieved by following inflation targeting method. (Svensson 1997) Thanks to inflation targeting that central banks and public established (Bernanke et al. 1999) improved lines of communication and share the information about where the economy is headed. Policy makers should focus more on maintaining inflation under control Friedman (1968) and while paying relatively less attention on unemployment. Their reasoning Phelps (1968) depended on that, accommodative monetary stances to lower unemployment may produce economy wide desired results only temporarily. Core inflation is better indicator than headline inflation in that the first Jose De Gregorio (2012) one signals inflationary pressure better than the latter one Focusing on either headline or core inflation depends on whether Tober and Zimmermann inflation is permanent or temporary. (2009) The main success factor of inflation targeting is to forecast the inflation Lars Svensson and accurately. Glenn Rudebusch (1999) Submitted By: Okan 4 Aybar, ETU20111319
Drawbacks of Inflation Targeting Claim Paper Inflation Targeting is not Perfect! Inflation Lars Svensson and Glenn Rudebusch (1999) targeting monetary policy framework is not perfect for its failure to respond to exogenous commodity price increases and asset price bubbles. Inflation targeting regime is too narrow and that it Mnyande (2009) focuses on consumer prices too much while ignoring the developments in the broader prices and markets in general. Commodity prices cannot be used effectively in (Marquis and Cunningham, 1990; Cody and formulating monetary policy because they are Mills, 1991). subject to large, market-specific shocks, which may not have macroeconomic implications Targeting inflation may cause interrupted Mishkin (1999) and Kad ı o ğ lu et al. production and unemployment. It may be a critical for a central bank to forecast (Svennsson 1999) and define the possible sources of the inflation. Submitted By: Okan 5 Aybar, ETU20111319
Commodities vs Inflation Claim Paper The overall index of commodity price, (Hassan and Salim, 2011) commodity price index for rural commodities, commodity price index for non-rural commodities and commodity price index for base metal commodities. They found these prices actually precede inflation. Submitted By: Okan 6 Aybar, ETU20111319
Commodities vs Monetary Policy Claim Paper Commodity Prices are in strong co-relation with Scrimgeour (2010) monetary policies as he found that every 10 basis points increase in interest rates cause commodity prices to fall by 0.5%. Commodity price movements are the result of (Bessler, 1984; macroeconomic/monetary factors and that the causality Pindyck and should run from macroeconomic/monetary variables to Rotemberg, 1990; commodity prices. Hua, 1998) Submitted By: Okan 7 Aybar, ETU20111319
What do Today’s Central Banks Look At? Claim Paper Commodity prices signals the future direction of the (Awokuse and economy. Yang, 2002) Monetary policy makers study macro-economic indicators (Weller, 2002) such as unemployment, real output growth and stock market returns which are used as important indicators for central banks. Commodity Prices + Inflation Targeting Macro Economic & Financial Indicators Submitted By: Okan 8 Aybar, ETU20111319
New Approach May Be Needed Commodity and Financial Futures Markets Convenience Yield Futures Adjusted Inflation Targeting Macro Economic & Financial Open Positions Indicators Submitted By: Okan 9 Aybar, ETU20111319
Convenience Yield vs Macro Data and Price Levels Commodity and Financial Futures Markets Convenience Yield Futures Adjusted Inflation Targeting Macro Economic & Financial Open Positions Indicators Futures Price: Spot Price + Carry Cost + Convenience Yield (Expectation) Claim Paper Convenience yields are conversely related to inventories Dinçerler et al. (2005) Convenience yields are negatively correlated with inventories. Brennan (1958) Concluded that individual and aggregate convenience yields of different Gospodinov and Ng., (2011 portfolios of commodities may explain commodity prices and futures prices may contain information about future economic conditions Convenience yield in general has predictive power on the inventory volume Stepanek et al. (2011) / turnover and future spot prices. Submitted By: Okan 10 Aybar, ETU20111319
Open Positions Data vs Commodity Prices Claim Paper Concluded that the CFTC data can be used to construct reliable (Basu et al. 2006) signals that tell a portfolio manager when to switch from equities into commodities and vice-versa. We reviewed evidence that positions in crude oil contracts (Hamilton et al. imputed from the reported agricultural holdings could help 2012) predict crude oil futures returns. Described a model, based on speculative positions in the (Pankki 2011) futures markets, which does a good job in forecasting the oil price one year forward. Commodity Prices are in strong co-relation with Monetary Scrimgeour (2010) Policies as he found that every 10 basis points increase in interest rates cause commodity prices to fall by 0.5%. Submitted By: Okan 11 Aybar, ETU20111319
Research Questions • CAN CONVENIENCE YIELD AND OPEN POSITIONS DATA BE EFFECTIVELY EMPLOYED TOGETHER TO ANTICIPATE THE FUTURE SPOT PRICES AND POSSIBLE DEMAND AND SUPPLY SHOCKS? • HOW CAN THE BEST PORTFOLIO OF FUTURES CONTRACTS, WHOSE CONVENIENCE YIELD AND OPEN POSITIONS, EXPLAINING THE HEADLINE INFLATION, BE CONSTRUCTED? • TO WHAT LEVEL OF ACCURACY CAN THE PROPOSED PORTFOLIO ANTICIPATE THE INFLATION? • HOW EFFECTIVELY CAN INFLATION TARGETING CENTRAL BANKS IMPROVE THEIR POLICY MAKING PROCEDURES IF THEY WERE TO ADOPT THE METHODOLOGY THAT WILL BE PROPOSED TO ANTICIPATE THE UNDERLYING INFLATION IN G7 COUNTRIES? Submitted By: Okan 12 Aybar, ETU20111319
Rationale It is important to spot inflation pressures correctly to successfully define moneytary policy. Effects of economic indicators and inflation on monetary policy and commodity prices have been the focus for monetary policy makers. Yet only few studies have been done to define the interaction between the commodity prices and economic indicators which contain ex ante data. If expectations components of futures prcies and open positions data are statistically linked with economic indicatrors, then economic indicators may be forecasted correctly thereby allowing the central bankers to act proactively. Although similar studies have been done, there is no academic paper that studied adjustment of economic indicators with expectations component of futures prices and open position data to reconstruct forecasts of economic indicators. This thesis aims to achive to deifne a methodology that the central banks may use in the future to successfully set monetary policies based on accurate forward looking indicators rather than lagged indicators. Submitted By: Okan 13 Aybar, ETU20111319
Methodology Methodology Who Used? Found What? Answ Granger Causality Ocran and Commodity prices can be used as signal for informing 1 Biekpe (2007) macroeconomic policy for possible actions in South Africa K ı ymaz and Causality to find observable long run relationships between Perdue (2009) energy prices and currency exchange rates. Verheyen (2010) Found there is strong link between commodity prices and consumer price index Bayesian Vector Auto Pankki (2008) An estimation framework of oil prices that tend to have 1 & 2 Regressive Modeling different character of risk premiums depending on different periods. Vector Error Correction Capolla (2008) An error correction model that considers the deviation of the 1 Model current state from its long-run relationship and feed the found relationship in to the short-run dynamics, to explore if the long-run relationship between spot and futures prices provides information about the future changes in spot and futures prices Regression Gregorio (2012) Technique to understand that food and energy have relevant 1 & 3 effects on inflation and that food prices have significant second round effects. Alquist and Used regression to estimate spread regressions to generate Kilian (2010) forecast of the oil price Submitted By: Okan 14 Aybar, ETU20111319
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