Abstract

http://ssrn.com/abstract=2201600
 
 

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A Model of Financialization of Commodities


Suleyman Basak


London Business School; Centre for Economic Policy Research (CEPR)

Anna Pavlova


London Business School; Centre for Economic Policy Research (CEPR)

July 5, 2014


Abstract:     
A sharp increase in the popularity of commodity investing in the past decade has triggered an unprecedented inflow of institutional funds into commodity futures markets, referred to as the financialization of commodities. In this paper, we explore the effects of financialization in a model that features institutional investors alongside traditional futures markets participants. The institutional investors care about their performance relative to a commodity index. We find that in the presence of institutional investors prices and volatilities of all commodity futures go up, but more so for the index futures than for nonindex ones. The correlations amongst commodity futures as well as in equity-commodity correlations also increase, with higher increases for index commodities. Within a framework additionally incorporating storage, we find that commodity spot prices and inventories go up with financialization. We show that in the presence of institutional investors shocks to any index commodity spill over to all storable commodity prices and inventories. Finally, we model explicitly demand shocks which allows us to disentangle the effects of the presence of institutional investors from the effects of demand and supply (fundamentals), and conclude that the effects of financialization are sizeable.

Number of Pages in PDF File: 57

Keywords: asset pricing, indexing, commodities, futures, institutions, money management, asset class

JEL Classification: G12, G18, G29

working papers series





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Date posted: January 18, 2013 ; Last revised: July 6, 2014

Suggested Citation

Basak, Suleyman and Pavlova, Anna, A Model of Financialization of Commodities (July 5, 2014). Available at SSRN: http://ssrn.com/abstract=2201600 or http://dx.doi.org/10.2139/ssrn.2201600

Contact Information

Suleyman Basak
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)
HOME PAGE: http://faculty.london.edu/sbasak/
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Anna Pavlova (Contact Author)
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)
HOME PAGE: http://faculty.london.edu/apavlova
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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