A tale of two premiums revisited

Abstract

This paper investigates the effect of the “financialization” of commodity markets in terms of pricing. I explore whether the emergence of commodity index traders (CITs) affects weekly returns and turnover during the roll periods. I split the sample (1994–2017) into prefinancialization (1994–2003) and postfinancialization (2004–2017). I directly test whether the CIT market share (CIT/open interest) contributes to commodity returns and whether risk adjustments (based on momentum, basis, basis‐momentum, open interest, crowding, and average factors) alter liquidity and insurance premiums documented in Kang, Rouwenhorst, and Tang. I also examine how the financialization affects liquidity and insurance premiums. Finally, since previous results are obtained with Fama–MacBeth regressions, I use an alternative method to test how liquidity and insurance premiums determine commodity returns.

Hedging pressure and oil volatility: Insurance versus liquidity demands

“…The other premium is the liquidity premium to account for the liquidity hedgers provide to momentum speculators, as speculators demand short-term liquidity and hedgers are willing to provide it (Cho et al, 2019). Zhang (2022) confirms the presence of these liquidity channels in commodity option markets as well, while Maréchal (2023) verifies financialization effects. Accordingly, these two risk premia, stemmed by the two measures of HP, establish two channels of liquidity provision; the traditional liquidity provision from speculators and the short-term liquidity provision from hedgers to momentum speculators.…”