Commodity_Financialization_Tang_and_Xiong_2009 -...

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1 Index Investing and the Financialization of Commodities Ke Tang and Wei Xiong Abstract This paper examines the financialization process of commodities precipitated by the rapid growth of index investment to the commodities markets since the early 2000s. We find that concurrent with the increasing presence of index investors, commodity prices have been increasingly exposed to market-wide shocks, such as shocks to the world equity index and US dollar exchange rate, and to shocks to other commodities, such as oil. In particular, this trend is more pronounced for commodities in the two popular commodity indices, the GSCI and DJ-AIG indices. As a result of the financialization process, the spillover effects of the recent financial crisis contributed substantially to the large increase in commodity price volatility in 2008. Our study thus highlights the increasingly important interactions between commodities markets and financial markets. The dramatic rise and fall of crude oil prices in 2008 (as shown in Figure 1) has stimulated increasing public attention and research interest in commodities markets. In particular, there is heated debate in policy circles about whether speculation caused unwarranted increases in the cost of energy and food and induced excessive price volatility. Both the Senate and the House have held hearings about this issue. Recently, the U.S. Commodity Futures Trading Commission (CFTC) said it would consider new measures to curb speculation. The surge in oil prices even prompted UK Prime Minister Gordon Brown and French President Nicolas Sarkozy to write a joint Wall Street Journal editorial in July 2009 to urge joint effort by international governments to supervise the energy markets. The ongoing debate attributes the recent rise and fall of oil prices either to a simple matter of supply and demand or to excessive speculation by index investors. According to the first view, which is emphasized by many economists, e.g., Krugman (2008), Hamilton (2009), and Kilian PRELIMINARY. This draft: September 2009. We wish to thank Nick Barberis, Alan Blinder, Markus Brunnermeier, Ing-Haw Cheng, Zhiguo He, Han Hong, Alice Hsiaw, Arvind Krishnamurthy, Tong Li, Burt Malkiel, Bob McDonald, Lin Peng, Mark Watson, and seminar participants at Princeton University for helpful discussion and comments. Renmin University of China, Email: Princeton University and NBER, Email:
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2 (2009), oil prices soared before the summer of 2008 because world demand had been rapidly increasing, propelled by booming economies such as China and India. Prices later fell sharply when the world recession caused demand to fade. The second view attributes the large volatility of oil prices to price distortions caused by the large investment flow to commodity indices.
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This note was uploaded on 10/13/2011 for the course FINM 300 taught by Professor Mr during the Spring '11 term at Adrian College.

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Commodity_Financialization_Tang_and_Xiong_2009 -...

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