Three essays on commodity markets

This dissertation is constituted of three distinct chapters on commodity markets, which cover different aspects of finance. The first chapter focuses on the consequences of the financialization of commodity markets, an important topic from a regulatory perspective. Using a multivariate change-point algorithm, I statistically date when the financialization materializes, with a narrow confidence interval. Using this date as a reference point, I use panel data methods to statistically assess the impact of the financialization on commodity futures prices. I find that it leads to a change in the risk-sharing structure, but without being detrimental neither for a typical investor nor for the functioning of commodity markets. The second chapter employs economically-motivated variables (time to maturity, inventories, and uncertainty resolution) and shows that they are significant determinants of the contemporaneous volatility. Moreover, for the long-term horizons, I find that these variables improve the out-of-sample forecasts of the most advanced high frequency-based, time-varying parameters, models. In a multi-quantile regression setting, I find that these variables do not yield more robust estimations for the out-of-sample expected shortfall. The third chapter explores whether the emergence of commodity index traders affects asset pricing properties (factors and characteristics). Using a Bayesian approach, I determine the optimal set of factors pricing commodity futures. I subsequently use this optimal risk adjustment to test how the financialization alters liquidity and insurance premia. Finally, I use a panel data method to test how these characteristics determine commodity returns, controlling for their potential correlation with factors. More broadly, this chapter also questions the existence of risk premia vs. pure characteristics (frictions) in the asset class of commodity derivatives, as advocated by e.g. Black (1976a), and calls for more research in this area.

Does Sentiments Impact the Returns of Commodity Derivatives? An Evidence from Multi-commodity Exchange India

The advancements in technology, increased accessibility to various modes and platforms of communication, and increased willingness on the part of participants to share their ideas/opinions has resulted in huge amounts of data on the World Wide Web, hence, easily available to impact decision-making. Furthermore, commodity prices are primarily driven by demand and supply, wherein such news is open to the cognitive thinking of individuals. Thus, using the principles of natural language processing, which combines concepts of linguistics, computer science and artificial intelligence, helps in improving the accuracy of price determination. Therefore, this article aims to examine the relationship between sentiments conveyed through various sources and the performance of India’s largest commodity market, multi-commodity exchange (MCX). The correlation and causation between sentiment scores extracted from such textual content and the daily returns of select commodity derivatives are analysed. The results show varying levels of significance of sentiments on the returns of commodity contracts and imply that there is an increased scope of using such unstructured content in the field of finance.

Does Commodity Derivatives Function Effectively? A lengthy Discussion

The present work has been designed to intensely investigate the capability of the commodity futures market in achieving the aim of price discovery. Further, the downside of the cash and futures market and transfer of the risk to other markets has also been studied using VaR, and Bivariate EGARCH. The findings of the work point that the metal commodity derivative market helps in the efficient discovery of price in the spot market except for nickel. But, in the case of the agricultural commodities, the spot is found to be leading and thus there is no price discovery except turmeric. On the other hand, the volatility spillover is bidirectional for both agri and metal commodities except copper, where volatility spills only from futures to spot. Further, the effect of negative shock informational bias differs from commodity to commodity, irrespective of metal or agriculture.

A Derivative is a Risk Hedging Tool from Investor Perspective

Derivatives products provide certain important economic benefits such as risk management or redistribution of risk away from risk-averse investors towards those more willing and able to bear the risk. Derivatives also help price discovery, i.e., the process of determining the price level for any asset based on supply and demand. These functions of derivatives help inefficient capital allocation in the economy; at the same time, their misuse also poses a threat to the stability of the financial sector and the overall economy. In the mid-1990s, India started reviving the exchangetraded commodity derivatives market. It introduced a variety of instruments in the foreign exchange derivatives market, while exchange-traded financial derivatives were introduced in 2001. Given India’s experience in informal derivatives trading, the exchange-traded derivatives were quick to pick up substantial volumes. This paper presents the concept of derivative and types of derivative products and how the investor perceives the derivative instrument as a risk-hedging tool in shivamooga city. The study is selected 70 respondents and used percentage analysis. The result obtained from the study reveals that the investor prefers a derivative is a risk-hedging tool.

3 Trading Venues

This chapter examines trading venues. The communiqué of the G20 finance ministers and central bank governors of 15 April 2011 states that participants in commodity derivatives markets should be subject to appropriate regulation and supervision. Therefore, certain exemptions from Directive 2004/39/EC (MiFID) are to be modified. These amendments particularly affect clearing houses, trade repositories, and trading venues, and reflect the increased risk and technological development since the last financial crisis. In Europe, MiFID II both defines the types of commodity derivatives that are regulated and the types of activity undertaken in relation to them that requires authorization. It also defines the types of trading venues that create the European trading landscape. As of January 2018, there are three types of trading venues in Europe: regulated markets, multilateral trading facilities, and organized trading facilities. While there are some important distinctions between them, it will be noted that many of the same requirements apply to each of them.

2 Commodity Trading Houses

This chapter discusses commodity trading houses, which refer to companies that buy and sell physical commodities and commodity derivatives for their own account and/ or on behalf of their customers. Commodity trading houses may be very specialist and deal in a few commodities only or they may have a wide-ranging business covering many different types of commodity. Moreover, commodity trading houses may form part of a wider group, where other parts of the group are in the business of producing commodities, whether that is by extracting them from the ground as a natural resource or manufacturing a usable product from one or more such resources. The commodity trading house may effectively be the marketing entity within the group. Sometimes that marketing entity will also enter into derivatives. The chapter then considers the reasons why commodity trading houses might trade commodity derivatives and the different ways in which such trading can be undertaken. It also studies the regulatory regime applicable to commodity trading houses and the reasons why such companies may fall within the scope of financial services regulation in some countries.