Will commodity futures reduce systemic risk in the spot market? Evidence from Chinese commodity market

Abstract

Purpose

This paper aims to investigate whether the establishment of commodity futures can effectively hedge systemic risk in the spot network, given the context of financialization in the commodity futures market.

Design/methodology/approach

Utilizing industry association data from the Chinese commodity market, the authors identify systemically important commodities based on their importance in the production process using multiple graph analysis methods. Then the authors analyze the effect of listing futures on the systemic risk in the spot market with the staggered difference-in-differences (DID) method.

Findings

The findings suggest that futures contracts help reduce systemic risks in the underlying spot network. Systemic risk for a commodity will decrease by approximately 5.7% with the introduction of each corresponding futures contract, since the hedging function of futures reduces the timing behavior of firms in the spot market. Establishing futures contracts for upstream commodities lowers systemic risks for downstream commodities. Energy commodities, such as crude oil and coal, have higher systemic importance, with the energy sector dominating systemic importance, while some chemical commodities also have considerable systemic importance. Meanwhile, the shortest transmission path for risk propagation is composed of the energy industry, chemical industry, agriculture/metal industry and final products.

Originality/value

The paper provides the following policy insights: (1) The role of futures contracts is still positive, and future contracts should be established upstream and at more systemically important nodes in the spot production chain. (2) More attention should be paid to the chemical industry chain, as some chemical commodities are systemically important but do not have corresponding futures contracts. (3) The risk source of the commodity spot market network is the energy industry, and therefore, energy-related commodities should continue to be closely monitored.

Citation

Liu, Q., Feng, Y. and Xu, M. (2024), "Will commodity futures reduce systemic risk in the spot market? Evidence from Chinese commodity market", China Finance Review International, Vol. 14 No. 4, pp. 791-812. https://doi.org/10.1108/CFRI-05-2023-0103