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A Model of Financialization of Commodities

61 Pages Posted: 18 Jan 2013 Last revised: 14 Sep 2015

Suleyman Basak

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

Anna Pavlova

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

Multiple version iconThere are 2 versions of this paper

Date Written: September 13, 2015

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 show how financial markets transmit shocks not only to futures prices but also to commodity spot prices and inventories. Commodity spot prices and inventories go up with financialization. In the presence of institutional investors shocks to any index commodity spill over to all storable commodity prices.

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

JEL Classification: G12, G18, G29

Suggested Citation

Basak, Suleyman and Pavlova, Anna, A Model of Financialization of Commodities (September 13, 2015). Journal of Finance, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2201600 or http://dx.doi.org/10.2139/ssrn.2201600

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://www.suleymanbasak.com

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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