On the transmission mechanism between the inventory arbitrage activity, speculative activity and the commodity price under the US QE policy: evidence from a TVP-VAR model

We investigate the transmission that relates the speculative activity, the inventory arbitrage activity, and the commodity price under the US quantitative easing (QE) policy. In this direction, a TVP-VAR model is adopted to test the transmission effect on seven commodities' prices using monthly data over the period 2003:4 to 2018:6. The evidence supports Frankel’s (2006) model on the transmission mechanism of the inventory arbitrage activity and the speculative activity on the effect of the real interest rate on commodities' real prices in the short run during the US QE policy period. Moreover, speculative activity appears to increase the effect of the interest rate on commodities' prices in the current period, whilst the evidence between inventory arbitrage activity and the interest rate on commodities' prices is found to be mixed. Further analysis indicates that the transmission of arbitrage activities concerning the effect of the interest rate on commodities' prices is influenced by the arbitrage condition between the commodity and the interest rate markets as well as the changes in commodities' futures basis. More specifically, the inventory arbitrage activities of precious metals and energy commodities play a significant role in transmitting the effect of the interest rate on their prices whilst energy commodities' price is more flexible than other commodities' prices in response to a shock from both inventory arbitrage and speculative activities. Lastly, the influence of the interest rate, the inventory arbitrage activity and the speculative activity is found to be stronger during the de-financialization period.