Real E ects of Financialization

The paper aims to investigate the real e ects of nancialization of commodities markets. We document that nancialization took a form of investment in short-term futures contracts that require regular replacement. Thus, nancialization exposes the nancial market to the stream of demand shocks, associated with replacement activity. If arbitrage is limited by risk aversion of nancial traders, the shocks are not fully absorbed and a ect futures prices. Because producers use futures to hedge, and in dispersed information setup all agents learn from the futures market, nancialization shocks propagate to the real economy. We introduce inventories to diminish the price discovery role of the nancial market. The media views inventories to be key to understanding what is happening in the commodity market. But we show that nancialization shocks propagate to inventories as well through the physical arbitrage conducted by midstream rms. We study welfare implications and show detrimental e ects of nancialization, especially on producers. ∗Northwestern University, Department of Economics. 2001 Sheridan Road, Evanston, IL 60208 (e-mail: [email protected]). Comments are welcome, errors are mine.