The Third Dimension of Financialization : Electronification, Intraday Institutional Trading, and Commodity Market Quality

We provide the first detailed empirical evidence on the financialization of intraday trading activity in the world's largest commodity market and show that this development had a first-order positive impact on market liquidity and pricing efficiency. We use a rich regulatory dataset to show that the electronification of U.S. crude oil futures trading in 2006 brought about a massive growth in intraday activity by “non-commercial” institutional financial traders. We exploit differences in the post-electronification growth rates of institutional financial trading in crude oil futures contracts of different maturities to tease out the effect of financialization on key metrics of commodity market quality. We show that increased institutional financial trading reduces the variance of pricing errors, narrows bid-ask spreads, and improves market depth. Our inferences are robust to differences in the nature and volume of non-financial trading. Finally, we provide novel evidence of notable differences between the respective contributions of high-frequency traders (HFTs) vs. other (non-HFT) institutional financial traders to different market quality attributes