Michel A. Robe

Commodities and Equities: Ever a 'Market of One'?

Amid the rise in commodity investing that started in 2003, many have asked whether commodities now move more in sync with traditional financial assets. Using daily, weekly and monthly data over 18 years, this article provides evidence largely to the contrary. First, dynamic conditional correlation and recursive co-integration techniques are applied to the prices of, and the returns on, key investable commodity and U.S. equity indices. Compared to the 1991–2002 period, both short- and long-term relationships between passive commodity and equity investments are generally weaker after 2003. Even though the correlations between equity and commodity returns increased sharply in the fall of 2008, during a time of extraordinary economic and financial turbulence, they remained lower than their peaks in the previous decade. Second, the co-movements between equity and commodity returns in periods of extreme returns are analyzed. There is little evidence of a secular increase in spillovers from equity to commodity markets during extreme events. Overall, the results suggest that while commodities provide substantial diversification benefits to passive equity investors, those benefits are weaker precisely when they are needed most.

The Impact of Illegal Insider Trading in Dealer and Specialist Markets: Evidence from a Natural Experiment

We examine insider trading in specialist and dealer markets, using the trades of stock brokers who had advance copies of a stock analysis column in Business Week magazine. We find that increases in price and volume occur after informed trades. During informed trading, market makers decrease depth. Depth falls more on the NYSE and Amex than on the Nasdaq. Spreads increase on the NYSE and Amex, but not on the Nasdaq. We find none of these pre-release changes in a nontraded control sample of stocks mentioned in the column. Our results show that insider trading has a negative impact on market liquidity; depth is an important tool to manage asymmetric information risk; and specialist markets are better at detecting informed trades.

Fundamentals, Trader Activity and Derivative Pricing

We identify and explain a structural change in the relation between crude oil futures prices across contract maturities. As recently as 2001, near- and long-dated futures were priced as though traded in segmented markets. In 2002, however, the prices of one-year futures started to move more in sync with the price of the nearby contract. Since mid-2004, the prices of both the one-year-out and the two-year-out futures have been cointegrated with the nearby price. We link this transformation to changes in fundamentals, as well as to sea changes in the maturity structure and trader composition of futures market activity. In particular, we utilize a unique dataset of individual trader positions in exchange-traded crude oil options and futures to show that increased market activity by commodity swap dealers, and by hedge funds and other financial traders, has helped link crude oil futures prices at different maturities.

Commodities and Equities: 'A Market of One'?

Amidst a sharp rise in commodity investing, many have asked whether commodities nowadays move in sync with traditional financial assets. Using daily, weekly and monthly data, we provide evidence that challenges this idea. Applying dynamic correlation and recursive cointegration techniques, we find that the relation between the returns on investable commodity and U.S. equity indices did not change significantly from January 1991 to May 2008. Importantly, we provide the first analysis of co-movement during periods of extreme returns. Again, we find no evidence of a secular increase in co-movement between the returns on commodity and equity investments during extreme events.

Physical Markets, Paper Markets and the WTI-Brent Spread

Since the Fall of 2008, the benchmark West Texas Intermediate (WTI) crude oil has periodically traded at unheard-of discounts to the corresponding Brent benchmark. This discount is not reflected in the price spreads between Brent and other benchmarks that are directly comparable to WTI. Drawing on extant models linking oil inventory conditions to the futures term structure, we test empirically several conjectures about how calendar and commodity spreads (nearby vs. first-deferred WTI; nearby Brent vs. WTI) should move over time and be related to storage conditions at Cushing. We then investigate whether, after controlling for macroeconomic and physical market fundamentals, spread behavior is partly predicted by the aggregate oil futures positions of commodity index traders.

Does 'Paper Oil' Matter? Energy Markets’ Financialization and Equity-Commodity Co-Movements

We construct a uniquely detailed, comprehensive dataset of trader positions in U.S. energy futures markets. We find considerable changes in the make-up of the open interest between 2000 and 2010 and show that these changes impact asset pricing. Specifically, dynamic conditional correlations between the rates of return on investable energy and stock market indices increase significantly amid greater activity by speculators in general and hedge funds in particular (especially funds active in both equity and energy markets). The impact of hedge fund activity is markedly lower in periods of financial market stress. Our results support the notion that the composition of trading activity in futures markets helps explain an important aspect of the distribution of energy returns, and have ramifications in the debate on the financialization of energy markets.

The financialization of food

Commodity-equity return co-movements rose dramatically during the Great Recession. This development took place following what has been dubbed the “financialization�? of commodity markets. We first document changes since 1995 in the relative importance of financial institutions’ activity in agricultural futures markets. We then use a structural VAR model to ascertain the role of that activity in explaining correlations between weekly grain, livestock, and equity returns in 1995-2015. We provide robust evidence that, accounting for shocks which are idiosyncratic to agricultural markets, world business cycle shocks have a substantial and long-lasting impact on the latter’s co-movements with financial markets. In contrast, changes in the intensity of financial speculation have an impact on cross-market return linkages that is shorter-lived and not statistically significant in all model specifications.

Optimal vs. traditional securities under moral hazard

This paper provides an explanation for the widespread use of traditional securities by well-established firms. Standard moral hazard models predict that equity, debt, and warrants are almost never optimal financing instruments. I show that issuing these securities is, nevertheless, nearly optimal: the issuer would gain very little by using non-traditional securities instead. Combined with equity, one debt issue (without multiple layers of seniority) and one warrant issue (without multiple exercise prices) suffice to achieve near optimality. The near optimality of traditional financing depends crucially on the issuers ability to use warrants in addition to debt and equity.

On the Welfare Cost of Business Cycles in Developing Countries

Economic fluctuations are much stronger in developing countries than in the United States. Yet, while a large literature debates what constitutes a reasonable estimate of the welfare cost of business cycles in the US, it remains an open question how large that cost is in developing countries. Using several model economies, we provide such a measure for a large number of low--income countries. Our first main result is that the welfare cost of consumption volatility per se is far from trivial in those countries, and always averages a substantial multiple of the corresponding estimate for the US. Our second major result is that, in many poor countries, the welfare gain from eliminating that volatility may in fact exceed the welfare gain from an additional 1 percentage point of growth in perpetuity.

The Potential of Foreign Aid as Insurance

In this paper, we argue that it would be fruitful to revisit foreign aids potential as an insurance mechanism against macroeconomic shocks. In a simple model of aid flows between two endowment economies, we show that at least three fourths of the large welfare costs of macroeconomic fluctuations in poor countries could be alleviated by a simple reallocation of aid flows across time.