Volatility Spillovers Arising from the Financialization of Commodities

Wing Chan,Bryce Shelton,Yan Wu

doi:10.3390/jrfm11040072

Wing Chan, Bryce Shelton + Show 1 more

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https://doi.org/10.3390/jrfm11040072

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Abstract

This paper examines whether the proliferation of new index products, such as commodity-tracking exchange-traded funds (ETFs), amplified the volatility transmission channel introduced by financialization. This paper focuses on the volatility spillover effects among crude oil, metals, agriculture, and non-energy commodity markets. The results show financialization has an impact on the volatility of commodity prices, predominantly for non-energy commodities. However, the impact on volatility is not symmetric across all commodities. The analysis of index investment and investors’ positions in futures markets shows that, when a relationship exists, it is generally negatively correlated with the realized volatility of non-energy commodities. Using realized volatility in the difference-in-difference model provides estimates that are inconsistent with other findings that non-energy commodities, traded as a part of indices, have experienced higher volatility. The results are similar to the index investment and futures market analysis, where increased participation by investors through new investment products has put download pressure on realized volatility.

Highlights

The rapid growth of index investment has greatly increased the ability for investors to access the commodity markets and, expedited the market integration of commodities
Similar to Tang and Xiong (2012), we find that non-energy commodities in S&P Goldman Sachs Commodity Index (GSCI) index have experienced higher volatility measured by pooled squared returns
The DID coefficients c2004, c2006, c2007, c2009 to c2012, and c2015, are positive and significant, indicating that non-energy commodities that are traded as a part of the S&P GSCI have experienced larger volatility increases than did off-index commodities

Summary

Introduction

The rapid growth of index investment has greatly increased the ability for investors to access the commodity markets and, expedited the market integration of commodities. Commodity markets are partially segmented from outside financial markets, and are mostly dominated by specialized investors, who provide insurance to hedgers to earn a risk premium. A conservative estimate shows that the commodity index traders more than quadrupled between 2000 and 2010 (Adams and Glück 2015). These new types of commodity index investors may lead to dramatic increase in commodity prices and market volatilities. Tang and Xiong (2012) provide empirical evidence that commodity index traders (CIT) lead to a transmission channel to spill volatility from outside financial markets onto, and across, commodity markets. The correlation between various non-energy commodities and oil increased markedly after

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