Globalization and Financialization of Emerging Commodity Futures

Abstract

The dramatic increase in commodity prices in recent years has raised concerns for scholars, practitioners and policy makers. The significant inflows of investment to commodity futures markets in recent decades have generated much debate as to whether the financialization process has an impact on commodity prices. Further debate questions whether the process of financialization may have been influenced by globalization. These two seem independent phenomena in the global markets but they are inter-related because of the increased capital mobility around the world, and may have affected commodity prices in two ways. First, commodity prices may be determined in the context of investible assets and not purely as consumables. Second, commodity prices may be determined in the global context rather than purely in the domestic markets. Inspired by these phenomena, this research aims to explore the impact of the globalization and financialization of commodity markets, especially from an emerging market perspective. Using Chinese and Indian markets as representative samples of emerging commodity markets, this research seeks the answer to the primary question: What are the impacts of globalization and financialization of commodity futures in the emerging markets? To address this question, this research poses three sub-questions that inter alia answer its primary research question. The first sub-question, regarding the information transmission among futures/spot markets, is addressed in the first study (Chapter 4): Does information spill over among agricultural commodity spot/futures markets in China and the futures market in the US? This study helps to understand both the pricing mechanism of commodities across three markets (futures/spot in China and futures in the US) and the integration of Chinese commodity markets in particular with the global commodity markets. The findings show a bi-directional relationship between futures and spot prices in China and between futures prices in China and the US. The results indicate that the information contained in commodity futures in emerging markets, such as the Chinese commodity futures market, starts to play an important price discovery role in developed commodity futures markets. The second sub-question, addressed in the second study (Chapter 5), regarding the volatility determinants of commodity futures, asks: What are the impacts of macroeconomic variables on the volatility of commodity futures? It examines the macroeconomic determinants of the volatility of commodity futures, with a focus on two emerging commodity markets, China and India. Further, this study employs both domestic and international macroeconomic variables and examines their impact on the volatility of commodity futures. The analysis shows that the commodity futures in emerging markets are determined by both domestic and international macroeconomic information. The third sub-question, which is addressed in the third study (Chapter 6), relates to the portfolio diversifications of using commodity futures in emerging markets: Are emerging commodity futures an effective investment vehicle for US investors to obtain diversification benefits? It examines the international diversification benefits that commodity futures in emerging markets can provide to the US portfolio investors. The evidence suggests that the commodity futures in emerging markets outperform the commodity futures in the US and are able to provide incremental portfolio benefits to US investors. The findings of these studies contribute to theory, practice and policy. Firstly, from a theoretical standpoint, there is a clear understanding that the pricing mechanisms have changed from purely domestic factors to international factors thanks to globalization and financialization. This research also contributes to the Modern Portfolio Theory by providing evidence that the financialization has caused the commodity futures in emerging markets to have a heterogeneous risk–return profile towards other asset classes. Furthermore, this research separates the information contained in the high-frequency daily prices and low-frequency macroeconomic conditions. This is critical for scholars who seek to investigate the influence of economic changes in volatilities of financial assets in the market. This research contributes to practice in three forms. First, the findings contribute to investment practice by explaining the risk-return characteristics of commodity futures in emerging markets. Second, understanding the macroeconomic determinants of the volatility of commodity futures is of value to portfolio managers, who aim to predict future movements of commodity prices. Third, finding conclusive evidence that the information flow is bi-directional rather than unidirectional from the US market to emerging markets is of significant importance for fund managers and investors. From a policy perspective, the findings of this research clearly show that the direct control of spot prices in commodity markets may not be a workable policy option as it may cause mispricing in the spot market in a long-run. Thus, policy makers may consider policies that aim to influence supply and/or demand side of the commodities rather than the direct price control. Policy makers who seek to design policies that provide attractive investment environment for investors, should also consider commodity futures in emerging markets.