A Model of Financialization of Commodities

61 Pages Posted: 16 Jun 2015

See all articles by Suleyman Basak

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: June 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 class, Asset pricing, commodities, futures, indexing, institutions, money management, spot prices

JEL Classification: G12, G18, G29

Suggested Citation

Basak, Suleyman and Pavlova, Anna, A Model of Financialization of Commodities (June 2015). CEPR Discussion Paper No. DP10651, Available at SSRN: https://ssrn.com/abstract=2619186

Suleyman Basak (Contact Author)

London Business School ( email )

Sussex Place
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London, London NW1 4SA
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HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Anna Pavlova

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)

HOME PAGE: http://https://www.anna-pavlova.co.uk/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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