Commodity Index Trading and Hedging Costs

Brunetti, Celso; Reiffen, David

doi:10.2139/ssrn.1727723

Commodity Index Trading and Hedging Costs

43 Pages Posted: 18 Dec 2010 Last revised: 15 May 2012

See all articles by Celso Brunetti

Celso Brunetti

Board of Governors of the Federal Reserve System

David Reiffen

U.S. Commodity Futures Trading Commission (CFTC)

Date Written: April 17, 2012

Abstract

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.

(Second Draft)

Keywords: index trading, hedging, limits to arbitrage, backwardation

JEL Classification: G11, G12, G13

Suggested Citation: Suggested Citation

Brunetti, Celso and Reiffen, David, Commodity Index Trading and Hedging Costs (April 17, 2012). Available at SSRN: https://ssrn.com/abstract=1727723 or http://dx.doi.org/10.2139/ssrn.1727723