The Role of Index Traders in the Financialization of Foods : A Behavioral Finance Approach

This paper proposes to investigate the impact of financialization on food prices over the last decades. To do so, we propose a new theoretical model in which chartistfundamentalist co-exist with institutional investors to identify trading signals in two different agricultural markets. Consistent with stylized facts, institutional investors operate in and out various markets at the same time through index investing. We find evidence that interactions between traditional traders and index investors cause price dynamics which closely mimic the behavior of agricultural prices. In particular, index traders not only drive prices away from fundamental but also significantly affect the positions of other traders in the markets. Moreover, we show the importance of index traders’ positions in increasing the evolution of markets correlations across commodities, and between commodities and equities especially during extreme movements. Our new theoretical model outperforms traditional chartist-fundamentalist approaches and constitutes a robust alternative to structural methods for modeling food prices (and commodity prices in general)