Question

1. Explain why commodity prices often exhibit mean reversion and are also sometimes subject to jumps.

Answer 1

Answer: Mean Reversion- It is a theory that suggests that commodity prices and their historical returns eventually revert to their long term mean/average levels. Commodity prices revet to their previous state. There are commodities whose current performance has differed significantly from their previous performance or average returns.

Commodities with high prices tend to have lower returns while commodities with low prices tend to have higher returns. Momentum does well in futures market while mean reversion does well in spot market but not in futures market.

Commodities are traded world wide. These are very risky investment alternative more than stocks. Commodities prices are based on global situations that is the reason, they are more volatile and have fluctuation in prices. They jump fastly and come down drastically.