Internal Characteristics And External Impacts Of International Commodity Markets' Financialization

As an extension of the concept of economic financialization,commodity markets' financialization refers to the growing participation of financial investors in commodity futures trading,the massive inflow of financial capital and hence the increasing importance of financial investors in commodity markets.The financialization of international commodity markets began in the early 21st century,due to the combined effect of deregulation of derivatives trading,turmoil in traditional financial markets and expansion of global liquidity.It developed rapidly during the period between 2004-2008 and accelerated further after the global financial crisis.The financialization process has led to profound changes in global commodity markets,which are especially embodied in the behavior of commodity prices.Along with the continuous influx of financial capital into commodity markets,commodity price dynamics have shown some unusual characteristics over the last decade:?in the aspect of one-dimensional characteristic,individual commodity prices have become much more volatile,with the frequency and magnitude of price fluctuations far exceeding historical levels;?in the aspect of multi-dimensional characteristic,the connectedness of prices across a broad set of commodities has risen considerably,suggesting a higher degree of commodity market integration.Generally,commodity price formation in the context of financialization is beyond what can be explained by supply-demand fundamentals,and seems to be closely related to the activity of financial investors.Given the important role of commodities in various fields of economy and finance,changes in commodity price dynamics caused by the financialization process certainly will bring severe challenges to many aspects such as investors' decision making,industrial development and economic operation.To have a thorough understanding of international commodity markets'financialization,it is necessary not only to analyze the consequences and underlying mechanisms of the financialization process from an internal perspective,but also to explore its spillover effect on other related fields outside commodity markets.Currently,the research on the financialization of commodity markets primarily focuses on the role of financialization in determining commodity prices.However,the conclusions are inconsistent and there are certain limitations in both research methods and research perspectives.Moreover,spillovers from financialization to other commodity-related fields have been seldom investigated,with impact analysis for financial investment and real economy particularly limited.In view of this,this dissertation takes the financialization of international commodity markets as the research subject,analyzing both the internal characteristics and the external impacts of financialization.Specifically,internal characteristics of commodity markets'financialization refer to the structural changes brought by financialization to commodity markets themselves,and external impacts of commodity markets'financialization refer to the effects of financialization on other fields outside commodity markets.With respect to the internal characteristics,we take the price formation mechanism as the cut-in point and try to link the underlying causes of the one-and multi-dimensional characteristics of commodity price dynamics to financial forces in commodity markets,thereby shedding light on the relationship between financialization and commodity price dynamics.With respect to the external impacts,we focus on detecting spillovers of financialization to the investment filed and the real economy.In particular,we first analyze the effect of financialization on portfolio optimization from the perspective of micro-investors and then examine the effect of financialization on Chinese industrial production from the perspective of macro-economy.In summary,the key point of this research is to find out how international commodity markets' financialization changes the price formation mechanism of commodities and what effects it has on the fields of financial investment and real economy.After decribing the manifestations,causes and key measures of commodity markets'financialization in detail,the dissertation discusses the key issues regarding the internal characteristics and external impacts of financialization thoroughly.The main contents and conclusions are as follows.(1)To identify the relationship between financialization and one-dimensional price dynamics of commodities,this paper empirically investigates the effects of financial speculation and real demand on individual commodity prices,and further discusses the role of financial investors in commodity price fluctuations based on the perspective of informational frictions.The results show that financial speculation has the property of informational noise,and real demand is the main driver of commodity prices in the long run,while financial speculation is the dominant force in the short run.In the short run,the impacts of financial speculation as well as other informational noises are stronger in high-volatility,high-financial stress and high-investor sentiment regimes than in regimes of weak informational frictions.Further analysis finds that the market share of financial investors is lower in regimes of strong informational frictions than in regimes of weak informational frictions.Accordingly,our research suggests that financialization acts as a "double-edged sword" in determining individual commodity prices:on one hand,it may cause violent fluctuations by generating large deviations from the fundamental level;on the other hand,it may make equilibrium prices more informative.Whether the former or the latter effect dominates depends on the degree of informational friction.Therefore,the key to stabilizing commodity markets in the context of financialization is to improve market transparency and reducing informational frictions.(2)To identify the relationship between financialization and multi-dimensional price dynamics of commodities,this paper builds a new analytical framework of cross-commodity linkages,namely excess spillovers,to assess the connectedness across a wide range of commodities that cannot be explained by economic fundamentals.The estimation results show that there exist significant excess spillovers among commodity prices.The magnitude of excess spillovers rose dramatically during 2004-2008 and peaked during the global financial crisis.Furthermore,different commodities assume different roles in the spillover network structure and the role of an individual commodity is time-varying.After characterizing the magnitude,direction and dynamics of excess spillovers across major commodities,the paper also employs regression analysis to directly investigate the relevance of financialization for the observed excess spillovers.The regression results indicate that the magnitude of excess spillovers is significantly positively related to the extent of participation by financial investors,and the majority of the variations in excess spillovers can be attributed to the activities of hedge funds and index traders.Besides,commodity markets with higher degree of hedge fund participation are more likely to be net transmitters of excess spillovers.In contrast,commodity markets with higher degree of index fund participation are more likely to be net receivers of excess spillovers.Overall,these findings verify that increasing integration of commodity markets in recent years is the new normal led by financialization,rather than a temporary change caused by fundamentals.Given this,in addition to monitoring the prices of commodities directly traded,the governments of both commodity importers and exporters should also establish multi-dimensional monitoring and early warning systems of international commodity prices.(3)To examine the impact of financialization on portfolio optimization,this paper selects futures contracts which are broadly representative of the investment opportunity in international commodity markets as the sample,and compares the benefits of introducing commodity futures under different degrees of financialization to a traditional portfolio which consists of stocks and bonds.The results show that adding commodity futures at high,medium and low levels of financialization will all contribute to the reduction of portfolio risk,while only adding commodity futures under the medium degree of financialization can simultaneously reduce portfolio risk and enhance portfolio return.The impact of financialization on portfolio optimization mainly manifests in the aspect of return rather than in the aspect of risk,and there is an inverted U-shaped relationship between the return enhancement ability of commodity futures and the degree of financialization.Accordingly,only under the moderate degree of financialization can investors achieve the maximum benefit by incorporating commodity futures in portfolios.The corresponding policy implications are as follows:on one hand,moderate financialization is beneficial for investors,and hence commodity futures exchanges should carry on product innovation and business model upgrading to encourage benign participation of financial capital;on the other hand,excessive financialization will erode the potential benefits of commodity investments,and thus regulatory authorities should strengthen the supervision of excess speculation and put forth effort to cultivate a rational investment atmosphere.(4)To ascertain how the financialization of international commodity markets affects the industrial sector in China,a VAR empirical framework is constructed based on theoretical analysis,within which the ultimate effect,the transmission channel and the impact mechanism of financialization on Chinese industrial production are explored progressively.The research finds that financialization amplifies the impact of international commodity price shocks on Chinese industrial production,that is,financialization has a magnifying effect on the fluctuations of Chinese industrial production.The magnifying effect is stronger during the global financial crisis as well as since 2014.Further analysis suggests that financialization affects Chinese industrial production primarily through the information channel and its magnifying effect can be explained by the mechanism of signal distortion.Based on the empirical findings,this paper emphasizes that China's macroeconomic policymakers must pay sufficient attention to the financialization process of international commodity markets,and should improve the early warning system to prevent the spread of external financial risks to domestic real sectors via the channel of international commodities.Besides,the government should release and interpret information about international commodity markets in time,correctly guiding public expectations.Finally,to fundamentally enhance the ability of resisting external shocks,China needs to deepen economic reform,increase strategic reserves of commodities and actively strive for commodity pricing power.The main contributions of this dissertation lie in the following four aspects.(1)Taking a broad range of representative commodities as research samples and fully considering the potential effects of financial crises and economic environment changes,this paper conducts a more comprehensive and accurate analysis of the relationship between financialization and commodity price dynamics.Moreover,relevant financial theories are applied to explain the empirical findings,not only helping to deepen our understanding of internal characteristics of financialization,but also expanding the application scope of related theories.(2)This paper makes an explicit identification of financial speculation which is exogenous and has the property of informational noise.On that basis,the effects of financial speculation and real demand on individual commodity prices in different market conditions are quantified and compared from the perspective of informational friction,and an in-depth analysis of the relation between financial activity and commodity price changes is carried out,through which the paper reveals the double-edged sword role of financialization in fluctuations of individual commodity prices.(3)This paper proposes the framework of excess spillovers by combining the idea of excess comovement with the method of spillover index,which allows us to examine the multi-dimensional connectedness across commodity prices that cannot be attributed to economic fundamentals in sufficient detail.Furthermore,the paper makes a thorough analysis of the relationship between financialization and excess spillovers from both the aspects of magnitude and direction,providing new evidence for financialization enhancing the internal integration of commodity markets.(4)Focusing on spillovers to the investment filed and the real economy,this paper conducts an exploratory research on the influence of commodity markets'financialization on portfolio optimization and Chinese industrial production,dialectically demonstrating the risks and challenges brought by the financialization of commodity markets to investment decision making,industrial development and economic operation.Analyses of those parts enrich the literature on the external impacts of financialization.