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Commodity index trading and hedging costs

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  • Brunetti, Celso
  • Reiffen, David

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. A key implication of the model is that CIT trading reduces the cost of hedging. We test the model using a unique non-public dataset that allows us to precisely identify trader positions. We find evidence, consistent with the model, that index traders have become an important supply of price risk insurance.

Suggested Citation

  • Brunetti, Celso & Reiffen, David, 2014. "Commodity index trading and hedging costs," Journal of Financial Markets, Elsevier, vol. 21(C), pages 153-180.
    • Handle: RePEc:eee:finmar:v:21:y:2014:i:c:p:153-180
    DOI: 10.1016/j.finmar.2014.08.001
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    More about this item

    Keywords

    Commodity index traders; Hedging; Limits to arbitrage;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models

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