Returns to Traders and Existences of a Risk Premium of a Risk Premium in Agricultural Futures Markets

Abstract

The purpose of the study is to examine the existence of a risk premium in futures markets to determine if hedgers pay speculators for protection against adverse price movements. Hartzmark (1987) addressed this same question but his time period of study from 1977 to 1981 is limited and outdated. The current state of the futures markets is quite different today than in was in the late 1970s. The data for this study extends from January 2000 to September 2009 and covers 12 commodity markets. The profitability of aggregate trader groups is calculated using end of day positions and prices for individual commodities; these commodities are then grouped according to price patterns over the sample period into three groups including grains (corn, soybeans, soybean oil, and wheat contracts), livestock (feeder cattle, lean hogs, and live cattle) in addition to cotton, and soft commodities (cocoa, coffee, and sugar). More importantly, long passive traders, called commodity index traders (CITs) emerged into the futures markets during 2004 and 2005 and provide a natural experiment to determine if naïvely holding positions opposite of hedgers results in positive profits and thereby evidence of a risk premium. Results do not find convincing evidence of the existence of a positive risk premium.

Keywords: commodities, futures markets, risk premium, commodity index traders

JEL Classification: D84, G12, G13, Q13, Q14