Futures Trading and the Excess Co-movement of Commodity Prices

We empirically reinvestigate the issue of the excess co-movement of commodity prices initially raised in Pindyck and Rotemberg (1990). Excess co-movement appears when commodity prices remain correlated even after adjusting for the impact of fundamentals. We use recent developments in large approximate factor models to consider a richer information set and adequately model these fundamentals. We consider a set of eight unrelated commodities along with 184 real and nominal macroeconomic variables, from developed and emerging economies, from which nine factors are extracted over the 1993-2013 period. Our estimates provide evidence of time-varying excess co-movement which is particularly high after 2007. We further show that speculative intensity is a driver of the estimated excess comovement, as speculative trading is both correlated across the commodity futures markets and correlated with the futures prices. Our results can be taken as direct evidence of the significant impact of financialization on commodity-price crossmoments. This paper was written in part while the authors were visiting the MSO Department at the London Business School, whose support and hospitality are greatly appreciated. We wish to thank the Associate Editor (Bernard Dumas) as well as a referee for insightful comments on our work. We are indebted to Lutz Kilian and Jaime Casassus for their many comments that led to significant improvements in the paper, and Derek Bunn, Paolo Pasquariello, and Christian Schluter for making useful remarks on an earlier version. Helpful comments by Laurent Ferrara, Francois Geerolf, Roselyne Joyeux, Fabien Tripier, and Ombretta Signori are also gratefully acknowledged. We thank Serena Ng for making available her Matlab package for large approximate factor models, and Pierre Perron and Yohei Yamamoto for their program to test for structural breaks. We are also grateful to participants at the 3emes Journees de l'Atelier Finance et Risque in Nantes (2010); the Forecasting Financial Markets Annual Meeting in Marseille (2011); the workshop in Development Economics in Aix-en-Provence (2011); the XXIth International Conference on Money, Banking and Finance in Rome (2012); the 30th International French Finance Association (AFFI) Conference in Lyon (2013); the 62nd Annual Meeting of the French Economic Association in Aix-en-Provence (2013); and the Commodity and Energy Markets Conference Annual Meeting in Oxford (2017). Y. L. P. acknowledges financial support by the project MIMO at the Foundation "Europlace Institute of Finance".