Speculator Spreading Pressure and the Commodity Futures Risk Premium

Abstract

This paper investigates the impact of speculative trading on the commodity futures risk premium. We focus on speculators’ spread positions, and study the asset pricing implications of spreading pressure on the cross-section of commodity futures returns. In an era of financialization of commodity markets, a long-short portfolio based on the spreading pressure signal carries a significant risk premium. We show that spreading pressure reflects speculators’ expectations about the change in the shape of the futures term structure, which is linked to commodity index investment. The spreading pressure factor can be explained by economic fundamentals and frictions introduced by financial traders.

Keywords: commodity financialization, speculative spread trades, commodity futures term structure

JEL Classification: G10, G13, G23