Do Speculators Wag the Dog? Maybe Not

BLOG: A soon-to-be-published Wharton paper suggests that hedgers may have something to teach the broader investing market.

Recent spikes in volatility for both commodities and equities have left many market watchers complaining about the inordinate influence of speculators, whose bets on these prices often are said to drive markets without reflecting underlying fundamentals.

But a recent study by Wharton School of Business finance professor Krista Schwarz finds fault with this “tail wags the dog” view, determining instead that the broader range of investors could learn much from the net positions of non-commercial hedgers.

Schwarz, whose paper “Are Speculators Informed? is being published in an upcoming issue of the Journal of Futures Markets, studied the relationship between hedgers and speculators, and returns in equity futures markets. She found that the “revelation of speculators’ positions is informative to investors more broadly,” supporting the view that these speculators possess “private information” that lead them to take their positions.

The Commodity Futures Trading Commission requires large participants in futures markets to report their positions weekly -- along with whether they are commercial hedgers using their futures positions to offset underlying business activities, or non-commercial speculators placing bets.

Schwarz looked at data about eight different types of equity futures contracts reported between October 1992 and June 2010 and found a “significant positive contemporaneous [italics in original] relationship between net non-commercial positioning changes and returns,” a relationship which “sticks” in that “the subsequent periods’ returns are not negatively correlated with positions in the current period.”

Writes Schwarz, “A potential explanation for this is that non-commercial participants have private information. I find a significant market reaction to the public release of information about position that supports the hypothesis of asymmetric information among trader types.”

Schwarz’s paper also takes aim at some long-accepted economic conjecture, saying that the evidence she collected in her study refutes John Maynard Keynes 1930 conjecture that futures market risk premiums should be related to positions because hedgers use futures markets to buy insurance.

While “some evidence for the Keynesian hedging pressure theory has been found in the context of commodity futures,” Schwarz says she finds “little evidence that hedging pressure explains equity futures risk premia, as Keynes had hypothesized.”