Financialization in Commodity Markets
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In a recent Staff Report published by the Federal Reserve Bank of Minneapolis, V.V. Chari and Lawrence J. Christiano examine the financialization view of commodity markets. This view holds that increased trading in commodity futures markets is associated with increases in the growth rate and volatility of commodity spot prices. The financialization view gained popularity because, starting in the early 2000s, trading activity in commodity futures markets increased sharply relative to its level in the 1990s, while many spot prices rose and became more volatile.
Chari and Christiano collected data on almost 200 traded and non-traded commodities. They investigated how these commodities behaved differently and also how the volume of trade in a commodity affects its price. They found essentially no support for the financialization view, and based on their observations, developed an alternative mutual insurance view. They formalize this view in a model and show that it is consistent with key features of the data.
Lawrence J. Christiano is the Alfred W. Chase Professor of Business Institutions at the Kellogg School of Management, Northwestern University.