Commodity exchange and hedge funds

Abstract

Hedge Funds should be allowed to trade in Commodity Future market or not has become a very hot debated topic in India. Hedge Funds, with them, bring liquidity in the system, but at the same time they may impact the economy very adversely. So before giving permission to operate the government should study the fundamentals of the market. One of the main criticisms against Hedge Funds is that they are very speculative. Though speculators are an essential part of a financial system, but over speculation is dangerous for the economy. So time to time the regulator should check the status of a market in terms of speculation and according it may take actions. In this CCS we tried to determine the presence of speculation in three segments of the commodity derivative market viz. Metals, Energy and Bullions. The 4th segment i.e. Agriculture is not touched upon. In Metal and Energy sector efficient frontier of derivatives are compared with efficient frontiers of stocks of companies manufacturing those products. So if we get the return on derivatives is less than that of stocks manufacturing those products, we could conclude that there is no evidence of speculation. In the study, we have proved that there is no speculation in 3 segments of the commodity futures market by comparing returns on derivatives with the returns on stocks of corresponding companies manufacturing these products.