Commodity prices are significantly more volatile than prices of industrial products. This extreme price instability establishes a need for futures markets in commodities. The main functions of futures trading being hedging against, and speculation on price fluctuations; and it is hedging, that determines the role of speculation. (author's abstract) / Series: Department of Economics Working Paper Series

The Thesis: Commodity prices are significantly more volatile than prices of industrial products. Production as well as non speculative demand of raw materials are subject to stochastic - sometimes even systematic - fluctuations, which get translated into pronounced price fluctuations by low short run price elasticities of demand and supply. Unstable prices as such provide an incentive to speculate; and - so the Friedman thesis - profitable speculation in itself has a stabilizing effect, since "speculation can be destabilizing in general only if speculators on average sell when the currency is low in price and buy when it is high". Temporal independence between speculative and non speculative activities is the only necessary condition Friedman considers. The counter argument: As can be shown however, even under the assumption of temporal independence speculation can have a destabilizing effect despite being profitable, if the non speculative excess demand is nonlinear. Moreover its precisely because of temporal interdependence on commodity markets, that speculative profits can even be achieved by destabilizing (stable) prices. The extreme volatility of commodity prices therefore may be partly caused by (profitable) speculation as well. (author's abstract) / Series: Department of Economics Working Paper Series