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What explains the growth in commodity derivatives?

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  • Parantap Basu
  • William T. Gavin

Abstract

This article documents the massive increase in trading in commodity derivatives over the past decade—growth which far outstrips the growth in commodity production and the need for derivatives to hedge risk by commercial producers and users of commodities. During the past decade, many institutional portfolio managers added commodity derivatives as an asset class to their portfolios. This addition was part of a larger shift in portfolio strategy away from traditional equity investment and toward derivatives based on assets such as real estate and commodities. Institu­tional investors’ use of commodity futures to hedge against stock market risk is a relatively recent phenomenon. Trading in commodity derivatives also increased along with the rapid expansion of trading in all derivative markets. This trading was directly related to the search for higher yields in a low interest rate environment. The growth was both in organized exchanges and over-the-counter (OTC) trading, but the gross market value of OTC trading was an order of magnitude greater. This growth is important to note because a critical factor in the recent crisis was counterparty failure in OTC trading of mortgage derivatives.

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Bibliographic Info

Article provided by Federal Reserve Bank of St. Louis in its journal Review.

Volume (Year): (2011)
Issue (Month): Jan ()
Pages: 37-48

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Handle: RePEc:fip:fedlrv:y:2011:i:jan:p:37-48:n:v.93no.1

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Related research

Keywords: Over-the-counter markets ; Derivative securities ; Commodity futures;

References

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  1. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-69, June.
  2. Parantap Basu & William T. Gavin, 2011. "Negative correlation between stock and futures returns: an unexploited dedging opportunity?," Working Papers 2011-005, Federal Reserve Bank of St. Louis.
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Cited by:
  1. Parantap Basu & William T. Gavin, 2011. "Negative correlation between stock and futures returns: an unexploited dedging opportunity?," Working Papers 2011-005, Federal Reserve Bank of St. Louis.
  2. Girardi, Daniele, 2012. "Do financial investors affect the price of wheat?," MPRA Paper 40285, University Library of Munich, Germany.
  3. Girardi, Daniele, 2012. "A brief essay on the financialization of agricultural commodity markets," MPRA Paper 44771, University Library of Munich, Germany.
  4. Girardi, Daniele, 2013. "Financialization of food - The determinants of the time-varying relation between agricultural prices and stock market dynamics," MPRA Paper 52043, University Library of Munich, Germany, revised 16 Nov 2013.
  5. Halova Wolfe, Marketa & Rosenman, Robert, 2014. "Bidirectional causality in oil and gas markets," Energy Economics, Elsevier, vol. 42(C), pages 325-331.
  6. María Rodríguez-Moreno & Sergio Mayordomo & Juan Ignacio Peña, 2012. "Derivatives Holdings and Systemic Risk in the U.S. Banking Sector," Faculty Working Papers 21/12, School of Economics and Business Administration, University of Navarra.
  7. Carfí, David & Musolino, Francesco, 2014. "Speculative and hedging interaction model in oil and U.S. dollar markets with financial transaction taxes," Economic Modelling, Elsevier, vol. 37(C), pages 306-319.

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