The Quality of Commodity Futures Markets

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In this research grant application, I outline a comprehensive study of commodity futures markets quality. My main objective is to analyze how the financialization of commodity markets has affected the two dimensions of market quality – liquidity and price efficiency – and how market quality is affected by the composition of different market participants. The arrival of index investors during the first half of the 2000s represents a drastic change in trader composition and has resulted in a discussion about the adverse effects of speculation on the functioning of markets. To measure market quality in, e.g., equity markets, the existing literature relies on the analysis of high-frequency intraday quote data. However, such data for commodity futures are only reliably available after 2008. In order to study market quality over a longer period, I plan to identify proxies based on daily or intraday Time and Sales data that allow me to extend the sample period to the pre-financialization period, for which high-frequency quote data do not exist. This will enable me to study the impact of the financialization of commodity markets on their quality. It will also permit a detailed analysis of the determinants of commodity market quality using different identification strategies, such as an event study of index weight changes, or a regression approach that uses positions data from the Commodity Futures Trading Commission (CFTC). The project will contribute to the understanding of the interplay between hedgers, speculators, arbitrageurs, and index investors in general and in commodity futures markets in particular. It will also provide insights into the question of how different market participants consume or provide liquidity, and how they affect price discovery. The results are relevant for the design and regulation of well-functioning markets, and thus of great interest for market participants and policymakers alike.