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Commodity index trading and hedging costs

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  • Celso Brunetti
  • David Reiffen

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. The model predicts that CIT trading reduces the cost of hedging. We test the model using a unique non-public dataset which precisely identifies trader positions. We find evidence, consistent with the model, that index traders have become an important supply of price risk insurance.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2011-57.

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Date of creation: 2011
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Handle: RePEc:fip:fedgfe:2011-57

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Related research

Keywords: Commodity futures - Mathematical models ; Hedging (Finance) - Mathematical models;

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References

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  1. Acharya, Viral V. & Lochstoer, Lars A. & Ramadorai, Tarun, 2013. "Limits to arbitrage and hedging: Evidence from commodity markets," Journal of Financial Economics, Elsevier, vol. 109(2), pages 441-465.
  2. Christian Francq & Lajos Horváth, 2011. "Merits and Drawbacks of Variance Targeting in GARCH Models," Journal of Financial Econometrics, Society for Financial Econometrics, vol. 9(4), pages 619-656.
  3. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
  4. Erkko Etula, 2009. "Broker-dealer risk appetite and commodity returns," Staff Reports 406, Federal Reserve Bank of New York.
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Cited by:
  1. Nicole M. Aulerich & Scott H. Irwin & Philip Garcia, 2013. "Bubbles, Food Prices, and Speculation: Evidence from the CFTC’s Daily Large Trader Data Files," NBER Working Papers 19065, National Bureau of Economic Research, Inc.
  2. James D. Hamilton & Jing Cynthia Wu, 2014. "Effects of Index-Fund Investing on Commodity Futures Prices," NBER Working Papers 19892, National Bureau of Economic Research, Inc.
  3. Irwin, Scott H. & Sanders, Dwight R., 2012. "Financialization and Structural Change in Commodity Futures Markets," Journal of Agricultural and Applied Economics, Southern Agricultural Economics Association, vol. 44(03), August.
  4. Irwin, Scott H., 2012. "Does the Masters Hypothesis Explain Recent Food Price Spikes?," Working Papers 126944, Structure and Performance of Agriculture and Agri-products Industry (SPAA).

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