Commodity tail risk and equity risk premia

Abstract

We explore the asset pricing implication of the commodity tail risk, constructed by aggregating individual commodity's exposure to left‐tail realizations of systematic risks, in cross‐sectional stock returns. Using Chinese data from 2005 to 2022, we find that the risk‐adjusted return differential between extreme portfolios is highly significant at 1.39% per month. The economic rationale is that a high level of commodity tail risk signals adverse economic conditions, and stocks that hedge the tail risk offer a low premium. Our findings highlight the informational role of commodity futures prices and the link between commodity and equity markets in China.