Is commodity trading to blame for price volatility?

French President Nicolas Sarkozy stated at the opening of the June G20 agricultural meeting that “the financialisation of agriculture markets… is a contributory factor in price volatility”. However, this is contradicted to Dr. Pierre Jacquet of the Agence Française de Développement, who notes that a number of market-based solutions could potentially help developing countries better manage commodity price volatility, including increasing access to risk-hedging instruments.

Since whether commodity derivatives trading increases price volatility is an empirical question, in a new position paper, Hilary Till, EDHEC-Risk Institute reviews evidences regarding the impact of commodity trading, speculation, and index investment on price volatility. The paper finds that the evidence for the prosecution does not seem particularly compelling at this point. The paper agree with the opinion of the World Bank president that the answer to food price volatility is not to prosecute or block markets, but to use them better. In the author’s view, one sensible use of financial engineering is for hedging volatile food price risk with appropriate commodity derivatives contracts.

This new position paper also echoes previous research results by EDHEC-Risk Institute that finds no evidence that speculation is a cause of high levels of volatility in commodity prices. Overall, the position, which is supported by the French presidency of the G20, is contradicted both by EDHEC Risk Institute’s own work and also by two empirical studies conducted by the two main international economic organisations, the IMF and the OECD.