Does 'Paper Oil' Matter? Energy Markets’ Financialization and Equity-Commodity Co-Movements

We construct a uniquely detailed, comprehensive dataset of trader positions in U.S. energy futures markets. We find considerable changes in the make-up of the open interest between 2000 and 2010 and show that these changes impact asset pricing. Specifically, dynamic conditional correlations between the rates of return on investable energy and stock market indices increase significantly amid greater activity by speculators in general and hedge funds in particular (especially funds active in both equity and energy markets). The impact of hedge fund activity is markedly lower in periods of financial market stress. Our results support the notion that the composition of trading activity in futures markets helps explain an important aspect of the distribution of energy returns, and have ramifications in the debate on the financialization of energy markets.