We analyze how institutional investors entering commodity futures markets, referred to as the financialization of commodities, affect commodity prices. Institutional investors care about their performance relative to a commodity index. We find that all commodity futures prices, volatilities, and correlations go up with financialization, but more so for index futures than for nonindex futures. The equity-commodity correlations also increase. We demonstrate how financial markets transmit shocks not only to futures prices but also to commodity spot prices and inventories. Spot prices go up with financialization, and shocks to any index commodity spill over to all storable commodity prices.
This paper develops a simple two-country, two-good model, in which the real exchange rate, stock and bond prices are jointly determined. The model predicts that stock market prices are correlated internationally even though their dividend processes are independent, providing a theoretical argument in favor of financial contagion. The foreign exchange market serves as a propagation channel from one stock market to the other. The model identifies interconnections between stock, bond and foreign exchange markets and characterizes their joint dynamics as a three-factor model. Contemporaneous responses of each market to changes in the factors are shown to have unambiguous signs. These implications enjoy strong empirical support. Estimation of various versions of the model reveals that most of the signs predicted by the model indeed obtain in the data, and the point estimates are in line with the implications of our theory. Furthermore, the uncovered interest rate parity relationship has a risk premium term in our model, shown to be volatile. We also derive agents' portfolio holdings and identify economic environments under which they exhibit a home bias, and demonstrate that an international CAPM obtaining in our model has two additional factors.JEL Classifications: G12, G15, F31, F36
This paper investigates a fund manager's risk-taking incentives induced by an increasing and convex fund-flows to relative-performance relationship. In a dynamic portfolio choice framework, we show that the ensuing convexities in the manager's objective give rise to a finite risk-shifting range over which she gambles to finish ahead of her benchmark. Such gambling entails either an increase or a decrease in the volatility of the manager's portfolio, depending on her risk tolerance. In the latter case, the manager reduces her holdings of the risky asset despite its positive risk premium. Our empirical analysis lends support to the novel predictions of the model. Under multiple sources of risk, with both systematic and idiosyncratic risks present, we show that optimal managerial risk shifting may not necessarily involve taking on any idiosyncratic risk. Costs of misaligned incentives to investors resulting from the manager's policy are demonstrated to be economically significant. JEL Classifications: G11, G20, D60, D81.
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