Hedge Funds, Volatility, and Liquidity Provision in Energy Futures Markets

Abstract

The role of speculators in derivatives markets has been a source of considerable interest. One large category of speculative traders, hedge funds, has drawn considerable attention in recent years. Much of the attention has focused on the concern that hedge funds exert a destabilizing effect on these markets, which may ultimately lead to higher trading costs. Employing a unique dataset consisting of trader positions in U.S. energy futures markets, this article analyzes trading relationships between hedge funds and other groups of traders (e.g., hedgers and other speculators). Results show that on average hedge funds do not change their positions as frequently as other groups. Results also show that, on average, changes in hedge funds positions are triggered by position changes of other trader groups. The article finds that hedge funds are an important source of liquidity to the other participants and the hypothesis that hedge fund trading causes price volatility in energy futures markets is rejected.