The Commodity Futures Trading Commission, long known for its “hands-off” regulatory policy, appears to be changing course toward greater intervention in markets. New research by professors at the Vanderbilt Owen Graduate School of Management finds that when it comes to index investors, more intervention is a mistake.
Hans R. Stoll, the Anne Marie and Thomas B. Walker Jr. Professor of Finance and co-director of the Financial Markets Research Center at Vanderbilt, and Robert Whaley, the Valere Blair Potter Professor of Management in Finance and co-director of the Financial Markets Research Center, are the authors of a new study, “Commodity Index Investing and Commodity Futures Prices,” analyzing the role of these popular indexes on commodity futures markets.
The study finds that commodity index investment, the practice by funds that buy baskets of commodities as a way to synthetically diversify an investment portfolio, is not speculation and that intervention by the Commodity Futures Trading Commission, urged by Congress, would harm more than help commodity futures markets.
“Commodity index rolls have little futures price impact, and inflows and outflows from commodity index investment do not cause futures prices to change,” said Whaley.
Stoll said a recent example proving their research was the hearings held last summer on the role of commodity index investors in pushing up commodity prices in 2007–2008.
“There’s no doubt that prices of a variety of commodities rose steeply in this period, but in our view there is considerable doubt that index investors caused the rise. Furthermore, prices have returned to more normal levels,” said Stoll. “The current desire to intervene in markets is all the more surprising in view of the success with which futures markets weathered the recent credit crunch. No organized futures exchange ran into serious difficulty and all contracts on all futures exchanges were satisfied.”
Also included in the study is a section on wheat futures. Stoll and Whaley found that the failure of the wheat futures prices to converge to the cash prices at the contract’s expiration has not undermined the futures contract’s effectiveness as a risk management tool.
The research, which was supported by a grant from Gresham Investment Management LLC, includes data from agriculture, livestock, industrial and precious metals, and energy commodities markets. It is also forthcoming in the Journal of Applied Finance.
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