An Anatomy of Commodity Futures Risk Premia

Abstract

We identify two types of risk premia in commodity futures returns: spot premia related to the risk in the underlying commodity, and term premia related to changes in the basis. Sorting on forecasting variables such as the futures basis, return momentum, volatility, inflation, hedging pressure, and liquidity results in sizable spot premia between 5% and 14% per annum and term premia between 1% and 3% per annum. We show that a single factor, the high‐minus‐low portfolio from basis sorts, explains the cross‐section of spot premia. Two additional basis factors are needed to explain the term premia.

Is idiosyncratic volatility priced in commodity futures markets?

“…Our study shows that the negatively priced idiosyncratic volatility extracted from unsuitable (traditional) benchmarks is an artifact of neglecting the inexorable phases of backwardation and contango of commodity futures markets. As a byproduct, our findings support the recent literature that underscores the information content of backwardation and contango not only as regards the pricing of commodities (Bakshi et al, 2015;Basu & Miffre, 2013;Szymanowska et al, 2014) but also as leading indicator of economic activity (Baker & Routledge, 2012;Bakshi et al, 2015;Fernandez-Perez et al, forthcoming). Table 6 Robustness of the time-series results.…”

“…Overall, the price of idiosyncratic volatility drops from an average of −0.39 in Table 4, Panel A to −0.18 in Table 4, Panel B. Additionally, we confirm that commodities with lower levels of liquidity and lower expected idiosyncratic skewness tend to earn more (Boyer et al, 2010;Szymanowska et al, 2014). Unlike Huang et al (2010) in the context of equities, we do not identify a onemonth return reversal in commodity futures markets.…”

“…(2). Following Szymanowska et al (2014), we consider the liquidity measure of Amihud et al (1997) as another explanatory variable for the cross-section of commodity futures returns. Appendix A gives details on the construction of these variables.…”

“…Following Szymanowska et al (2014), we measure daily liquidity using the Amihud et al (1997)'s definition as the average ratio of a given contract dollar-volume to the absolute return of that contract; the average is computed over the same R months of daily data used to extract the idiosyncratic volatility signal. The thus-obtained expected idiosyncratic skewness and liquidity measures are included as additional factors in the benchmark, Eq.…”

“…Various trading strategies that empirically validate the predictions from these theories have been shown to generate attractive performance by systematically buying backwardated contracts with high roll-yields, scarce supply, net short hedgers, net long speculators and good past performance, and shorting contangoed contracts with low roll-yields, abundant supply, net long hedgers, net short speculators and poor past performance (Bakshi, Gao, & Rossi, 2015;Basu & Miffre, 2013;Erb & Harvey, 2006;Gorton, Hayashi, & Rouwenhorst, 2012;Gorton & Rouwenhorst, 2006;Miffre & Rallis, 2007;Szymanowska, de Roon, Nijman, & Van Den Goorbergh, 2014). Additional signals that have been shown to generate significant spreads in commodity futures returns are associated with value, liquidity, skewness or total volatility (Asness, Moskowitz, & Pedersen, 2013;Fernandez-Perez, Frijns, Fuertes, & Miffre, 2016;Gorton et al, 2012;Szymanowska et al, 2014).…”