The Price of Commodity Risk in Stock and Futures Markets

Abstract

We find that commodity risk is priced in the cross-section of US stock returns. Following the financialization of commodities, investors hedge commodity price risk directly in the futures market, primarily via commodity index investments, whereas before they gained commodity exposure mainly via the stock market. As a result, we find that the annualized average returns of high-minus-low commodity beta stocks change from -8% pre-financialization to 11% post-financialization. As stock market investors increasingly participate in commodity futures markets, stock market risk is also priced in the cross-section of commodity futures returns.

Keywords: Asset pricing, Commodity futures markets, Commodity index investment, Commodity risk premium, Hedging

JEL Classification: G11, G12, G13