Speculative Cotton Pricing in the 1920s. A Nonlinear Tale of Noise Traders and Fundamentalists

The paper investigates the role of speculation in the Liverpool cotton futures market between 1921 and 1929. The analysis is based on historical descriptions of the working of speculation in commodity markets and is related to the tenets of behavioural finance. The model posits the existence of two categories of speculators, noise traders and fundamentalists, who react (differently) to deviations of market prices from their fundamental value. The empirical analysis is based on original data drawn from the online archives of The Times. The empirical findings allow us to conclude that whereas noise traders tend to herd, fundamentalists are more affected by risk aversion and react asymmetrically more to underpricing than to overpricing of the cotton contracts. As expected, the presence of fundamentalists stabilizes the market. Interestingly our results seem to be consistent with the observations of expert witnesses of those markets.