This is a comprehensive study of the growth and impact of agricultural futures market traders. The growth of financial investment in commodities has introduced participants and raised both new questions and warranted revisiting old questions; these include the impact on commodity prices, the profitability of traders, and the existence of trading skill. To address these questions twelve commodity markets are chosen to capture the majority of agricultural trading on organized futures markets and encompass the agricultural commodity index trading activity. The data used are from the proprietary large trader database of the Commodity Futures Trading Commission (CFTC) that details individual trader end of day positions and covers the years 2000 to 2009.
The growth of index fund investment from 12billionin2002toover200 billion by 2008 initiated a debate on whether index funds are ???too big??? for the current size of commodity futures markets. Concerns emerged regarding their adverse effects on prices and volatility. The impact of the financial investment of index traders is analyzed using Granger Causality tests. The analysis investigates three different scenarios: (i) aggregated commodity index trader positions impacts on returns or volatility, (ii) changes in returns or volatility effects on aggregate commodity index trader positions, and (iii) disaggregated commodity index trader positions effects on contract returns or volatility during the roll period. Results show index traders do not have a widespread impact on returns or volatility and in some cases actually decrease volatility bringing stability to the marketplace. The futures markets have adjusted to the presence of the new financial participants and continue to provide price discovery and risk management. The results have important implications for the ongoing policy debate surrounding index investment; in particular, the results do not support limiting participation of index fund investors.
The returns to traders are analyzed to determine if a risk premium in agricultural futures markets exists, where hedgers pay speculators for protection against adverse price movements. The existence of a risk premium is often touted as a motivation factor for speculative trading. The long, passive index traders that emerged as major participants in 2004 and 2005 provide a natural experiment to determine if na??vely holding positions opposite of hedgers results in positive profits and thereby evidence of a risk premium. Even in the presence of increased prices and volatility that encourage the transfer of risk, no risk premium is found. CITs do not display evidence of receiving a risk premium by earning consistent positive returns but rather experience large losses in aggregate whereas noncommercial traders experience positive profits. The absence of a risk premium may occur because an infinitely elastic supply of speculative services results in the risk premium being bid to zero or the risk absorbing role is usurped by liquidity demands of index traders.
Finally, speculative, noncommercial traders are analyzed to determine if they persist in making profits or if profits are randomly generated. The study focuses on three important and representative commodities; corn for field crops, live cattle for livestock, and coffee for soft commodities. Two methods are used to analyze the persistent ability of traders to generate positive outcomes: (i) the first is the Fisher Exact test, a nonparametric two-way winner and loser rank contingency table analysis, and (ii) the second is the testing of trader by magnitude of profits using the rank of trader profits in the first period to identify top and bottom deciles. The results indicate that the top 10% of traders have substantial ability to persistently perform; this is about 5-8% more traders than identified in other studies of agricultural futures traders. The rigorous out-of-sample procedures used in this essay provide compelling evidence of the importance of skill in trader returns, and may help explain their continued presence in futures markets in the absence of a risk premium
