Bubbles, Froth and Facts: Another Look at the Masters Hypothesis in Commodity Futures Markets

Abstract

The Masters Hypothesis suggests that long‐only index funds were the main cause of a massive increase in commodity prices in 2007–2008 and 2011–2012. Central to the Masters Hypothesis are three basic tenets: (i) long‐only commodity index funds were directly responsible for driving futures prices higher; (ii) the deviations from fundamental value were economically very large; (iii) the impact was pervasive across commodity futures markets. There has been a great deal of empirical research on the Masters Hypothesis and commodity market bubbles. However, surprisingly few studies have found evidence that directly support the main tenets of the Masters Hypothesis. Some have attributed the lack of supporting evidence to the low‐power of time‐series tests, market efficiency issues and a lack of conditioning variables within models. In this paper, we address each of these issues using updated data and new empirical approaches. Still, price behaviour consistent with the Masters Hypothesis is surprisingly difficult to find in the data. This is an important finding given the on‐going policy debate and regulations proposed or being implemented to limit speculative positions in these markets.

Did index trader and swap dealer activity produce a bubble in the agricultural commodity market?

“…However, Masters" hypothesis shows some weaknesses. The "skeptics", including Headey and Fan (2008), Brunetti and Büyüksahin (2009), Irwin et al (2009), Till (2009), Aulerich et al (2009), , Stoll and Whaley (2010), Buyuksahin and Harris (2011), Capelle-Blancard and Coulibaly (2011), Irwin et al (2011), Hamilton and Wu (2012), Rouwenhorst and Tang (2012), Sanders and Irwin (2013), Sanders and Irwin (2016), and Etienne et al (2017), argue in fact that the bubble hypothesis has several critical aspects and is not consistent with typical market mechanisms.…”

“…In order to overcome possible limits of the Granger Causality test, Sanders and Irwin (2016) test the same relationship investigated by Etienne et al (2017) using a Fama-MacBeath regression, considering the 19 markets appearing in the IDD reports. Their estimations, conducted from 2008 to 2015 on annual, quarterly and monthly data, show no positive relationship between CIT positions and commodities market returns.…”

The Lead–Lag Relationship between Oil Futures and Spot Prices—A Literature Review

“…However, Irwin and Sanders (2012) results do not support this hypothesis and find no evidence of index positions influencing returns or volatility in 19 commodity futures markets. Sanders and Irwin (2017) reviewed this theory in a later study covering two periods (2007-2008 and 2011-2012) and using updated data and new empirical approaches. Nevertheless, they found it difficult to draw connections between their findings and the tenets of the Masters Hypothesis.…”

“…Nevertheless, they found it difficult to draw connections between their findings and the tenets of the Masters Hypothesis. They noted that the lack of supporting evidence is due to the low-power of time series tests, market efficiency issues and lack of conditioning variables within the models (Sanders and Irwin 2017).…”

How financial investment distorts food prices: evidence from U.S. grain markets

“…Empirical evidence for a causal link between financial investment and commodity price dynamics has been mixed; see Irwin () and Cheng and Xiong (), for comprehensive literature reviews. Most empirical studies have focused on the impact of commodity indices on price levels and volatilities, such as Ott (), Sanders and Irwin (), and Algieri (, ). Few have looked at convergence, market basis, or term structure effects.…”