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The Quality of Commodity Markets: Evidence from Options Markets

Subject Area Management and Marketing
Term since 2022
Project identifier Deutsche Forschungsgemeinschaft (DFG) - Project number 510760579
 
In this research grant application, I outline a comprehensive study of commodity option market quality. My main objective is to understand the drivers of market quality and relate it to the major changes commodity markets underwent over recent decades. These changes are (1) the arrival of large financial investors (financialization), (2) the migration of trading volume from open-outcry to electronic limit order markets (electronification), and (3) the surge in high-frequency trading. With this analysis, I intend to complete the picture drawn in a previous DFG-funded project, in which I study the market quality of commodity futures markets. Due to much clearer no-arbitrage relationships and increased hedging difficulties of liquidity suppliers, I expect option market quality estimates to be less noisy compared to those derived from futures markets alone.To measure commodity option market quality, I will rely on the detection of put-call-parity violations and return-predictability using intra-day Time-and-Sales and quote data. This will allow me to identify ist contract specific determinants in order to understand the challenges market makers face. Second, in a next step, I will study systematic relationships among commodities in the whole cross-section and within sectors in order to understand their relevant determinants. Lastly, I will quantify the impact of commodity financialization, electronification and high-frequency trading on market quality. I plan to use positions data curated by the Commodity Futures Trading Commission (CFTC) disaggregated into futures and options, as well as the timing of uncertainty resolution extracted from options data. The project will provide an understanding of commodity option market quality, shed light on the challenges traders in these markets face, and how these have changed over time, especially in light of the ongoing heated debate on the role of purely financial traders and high-frequency trading. The results are relevant for the design and regulation of well-functioning markets, which is of crucial interest for market participants and policymakers alike.
DFG Programme Research Grants
 
 

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