Never a Dull Moment: Entropy Risk in Commodity Markets

50 Pages Posted: 14 Dec 2018 Last revised: 6 Feb 2019

See all articles by Fousseni Chabi-Yo

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management

Hitesh Doshi

University of Houston - C.T. Bauer College of Business

Virgilio Zurita

Baylor University

Date Written: January 28, 2019

Abstract

We examine the role of entropy risk in explaining the cross-section of commodity returns motivated by a theoretical model. We show that the commodity's entropy, a summary of all higher moments of returns, captures the dispersion of the stochastic discount factor and therefore affects expected excess returns. We compute entropy risk premiums as the difference between the physical and risk-neutral measures of entropy, estimated from the commodity futures and options market. We form entropy-based portfolios, and find that commodities with high ex-ante entropy risk premium have higher subsequent returns. The results from the strategy hold after controlling for variance and skewness risk premiums, and are robust to global and commodity specific risk factors.

Keywords: commodity returns; entropy; options; risk premium

JEL Classification: G12, G13

Suggested Citation

Chabi-Yo, Fousseni and Doshi, Hitesh and Zurita, Virgilio, Never a Dull Moment: Entropy Risk in Commodity Markets (January 28, 2019). Available at SSRN: https://ssrn.com/abstract=3300843 or http://dx.doi.org/10.2139/ssrn.3300843

Fousseni Chabi-Yo

University of Massachusetts Amherst - Isenberg School of Management ( email )

Amherst, MA 01003-4910
United States

Hitesh Doshi (Contact Author)

University of Houston - C.T. Bauer College of Business ( email )

Houston, TX 77204-6021
United States

Virgilio Zurita

Baylor University ( email )

Waco, TX 76798
United States

Register to save articles to
your library

Register

Paper statistics

Downloads
120
Abstract Views
492
rank
231,636
PlumX Metrics