Does “Paper Oil” Matter? Energy Markets’ Financialization and Co-Movements with Equity Markets

We revisit, and document new facts regarding, the financialization of U.S. energy markets in 2000–2010. We show that, after controlling for macroeconomic factors and physical energy market fundamentals, the strength of energy markets’ co-movements with the U.S. stock market is positively related to the energy paper market activity of hedge funds that trade both asset classes. This relation weakens when credit risk is elevated. We find, in contrast, no link with the aggregate positions of commodity index traders in energy futures markets. Our findings have implications for the ongoing debate regarding the financialization of commodities.