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A Model of Financialization of Commodities

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  • SULEYMAN BASAK
  • ANNA PAVLOVA

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.
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Suggested Citation

  • Suleyman Basak & Anna Pavlova, 2016. "A Model of Financialization of Commodities," Journal of Finance, American Finance Association, vol. 71(4), pages 1511-1556, August.
    • Handle: RePEc:bla:jfinan:v:71:y:2016:i:4:p:1511-1556
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    File URL: http://hdl.handle.net/10.1111/jofi.2016.71.issue-4
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    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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