Commodity Index Trading and Hedging Costs
43 Pages Posted: 18 Dec 2010 Last revised: 15 May 2012
Date Written: April 17, 2012
Trading by commodity index traders (CITs) has become an important aspect of financial markets over the past 10 years. We develop an equilibrium model of trader behavior that relates uninformed CIT trading to futures prices. The model predicts that CIT trading reduces the cost of hedging. We test the model using a unique non-public dataset which precisely identifies trader positions. We find evidence, consistent with the model, that index traders have become an important supply of price risk insurance.
Keywords: index trading, hedging, limits to arbitrage, backwardation
JEL Classification: G11, G12, G13
Suggested Citation: Suggested Citation