Is Financial Speculation with Agricultural Commodities Harmful or Helpful? (Digest Summary)

The authors review and summarize recent literature (2010–2012) about the effect of financial speculation on the price level and volatility of agricultural commodities and the implications for regulation. They provide an informative context for the public debate concerning the fear that commodity index traders (CITs) might increase both food prices and the potential for global hunger. This hypothesis—named the “Masters hypothesis” after Michael Masters, who set up the organization Better Markets—has become quite popular, although it is not well supported in the literature. They also highlight the importance of interdisciplinary cooperation with other resource economists (e.g., energy) and offer recommendations for further research.

This literature review is of interest to both researchers and practitioners. CITs handle passively managed, long-only funds that roll contracts continuously. Because CITs have emerged relatively recently amid a volatile period for agricultural commodities, the debate over their potential influence on food prices has been intense and may have a significant impact on recommendations for regulations affecting financial markets.

In general, most of the research from this period (2010–2012) found no evidence that financial speculation affects price levels (8/8 journal articles and 10/19 articles in the so-called gray literature, which is specialized literature outside the usual sources). Most of the research also found no statistically significant evidence of any negative medium- to long-term impact of CITs on price volatility (4/4 journal articles and 9/13 gray literature). The authors note that both the quality and the results of the gray literature were more varied.

Regarding regulation, the authors find that most of the research either cautioned against regulation or cited the positive effects of CITs (7/7 journal articles and 8/13 gray literature). Positive effects include added liquidity, price discovery, information efficiency, and risk distribution. Several pieces in the gray literature disagreed, arguing for position limits and/or a transaction tax.

The authors propose further studies to examine the mechanism of transmission from the futures market to the spot market and the influence of trading volume on volatility and price level.

The authors review 35 articles on financial speculation in agricultural commodities published between 2010 and 2012 that cover various time frames, mostly in the period 2000–2010. Ten of the pieces are academic, peer-reviewed articles that use econometric methods of time-series analysis. The remaining 25 articles, from high-quality gray literature, are included to expand the sample size. Data from the two sample sets are presented separately, in both text and tables. Data are organized around the three main questions concerning the influence of financial speculation on (1) price level, (2) price volatility, and (3) the implications for regulation.

The authors’ review of the literature is asymmetrical. They explain that because the econometric studies formulated their null hypothesis as “speculation not having negative effects on price levels or volatility,” if the null hypothesis was rejected, they were able to examine the data and methodology more critically than if the null hypothesis was not rejected. As a result, the authors are very critical of any research that found potential evidence of the negative impact of financial speculation, calling most of these findings and methodologies debatable.

The authors conclude their review by highlighting areas or aspects that they believe require further research.

This important topic is certainly in need of a literature review. Although the authors present their review clearly, there is a concern that the research may not be presented without bias. In addition to the asymmetrical slant described earlier, some of the authors’ comments—for example, they state that the “vast majority” of papers support a particular view when actually only 10 of 19 papers, a slight majority (52%), support that view—may cause readers to question their other conclusions.