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What explains the growth in commodity derivatives ?

By P. Basu and W.T. Gavin

Abstract

This article documents the massive increase in trading in commodity derivatives over the past\ud decade—growth that far outstrips the growth in commodity production and the need for derivatives\ud to hedge risk by commercial producers and users of commodities. During the past decade,\ud many institutional portfolio managers added commodity derivatives as an asset class to their portfolios.\ud This addition was part of a larger shift in portfolio strategy away from traditional equity\ud investment and toward derivatives based on assets such as real estate and commodities. Institu -\ud tional investors’ use of commodity futures to hedge against stock market risk is a relatively recent\ud phenomenon. Trading in commodity derivatives also increased along with the rapid expansion of\ud trading in all derivative markets. This trading was directly related to the search for higher yields\ud in a low interest rate environment. The growth was both in organized exchanges and over-thecounter\ud (OTC) trading, but the gross market value of OTC trading was an order of magnitude greater.\ud This growth is important to note because a critical factor in the recent crisis was counterparty\ud failure in OTC trading of mortgage derivatives

Publisher: Federal Reserve Bank of St. Louis
Year: 2010
OAI identifier: oai:dro.dur.ac.uk.OAI2:8067
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