Commodity Financialization: Risk Sharing and Price Discovery in Commodity Futures Markets

Abstract

We study how commodity financialization affects trading behavior, prices, and welfare through affecting risk sharing and price discovery in futures markets. Our analysis highlights a supply channel through which the futures price feeds back into the later spot price. This feedback effect tends to reduce price efficiency but improve welfare. Consistent with recent evidence, we show that financial traders either provide or demand liquidity in the futures market, depending on the information environment, and that commodity financialization reduces the futures price bias through broadening risk sharing and injecting information into the market. Commodity financialization also has important welfare implications.