Carry Trades and Tail Risk: Evidence from Commodity Markets
47 Pages Posted: 19 Sep 2017
Date Written: November 17, 2017
I investigate the linkage between carry trades and tail risk for a panel of commodity futures contracts. Unlike other asset classes, carry in commodities is highly volatile both in the time series and in the cross section. By using a Bayesian panel quantile regression with commodity fixed effect, I document the tail-specific effect of carry on the conditional distribution of futures returns both in the short-term and in longer-term. The main empirical results show that carry has a significant effect on tail risk mostly in the short term and for the front end of the futures curve. The empirical evidence also shows that non-natural hedgers, such as managed money and index traders, tend to unwind their net-long futures positions when exposed to deteriorating aggregate financial conditions. This is consistent with existing theoretical models in which speculators and insurance providers are subject to limited risk capacity and financing liquidity constraints.
Keywords: Commodity Markets, Carry Trades, Bayesian Quantile Regressions, Tail Risk, Empirical Asset Pricing, Risk Management.
JEL Classification: G12, G17, E44, C58
Suggested Citation: Suggested Citation