Commodity Futures Return Predictability and Intertemporal Asset Pricing

44 Pages Posted: 28 Apr 2022

See all articles by John Cotter

John Cotter

University College Dublin

Emmanuel Eyiah-Donkor

University College Dublin (UCD) - UCD School of Business

Valerio Potì

University College Dublin

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Abstract

We find out-of-sample predictability of commodity futures excess returns using combination forecasts of 28 potential predictors. Such gains in forecast accuracy translate into economically significant improvements in certainty equivalent returns and Sharpe ratios for a mean-variance investor. Commodity return forecasts are closely linked to the real economy. Return predictability is countercyclical, and the combination forecasts of commodity returns have significant predictive power for future economic activity. Two-factor models featuring innovations in each of the combination forecasts and the market factor explain a substantial proportion of the cross-sectional variation of both commodity and equity returns. The associated positive risk prices are consistent with the intertemporal capital asset pricing model (ICAPM), given how the predictors forecast an increase in future economic activity in the time-series. Overall, combination forecasts act as state variables within the ICAPM, thus resurrecting a central role for macroeconomic risk in determining expected returns on commodities.

Keywords: Commodity futures, Return predictability, Asset allocation, Business cycle, Intertemporal asset pricing

Suggested Citation

Cotter, John and Eyiah-Donkor, Emmanuel and Potì, Valerio, Commodity Futures Return Predictability and Intertemporal Asset Pricing. Available at SSRN: https://ssrn.com/abstract=4095741 or http://dx.doi.org/10.2139/ssrn.4095741

John Cotter

University College Dublin ( email )

School of Business, Carysfort Avenue
Blackrock, Co. Dublin
Ireland
353 1 716 8900 (Phone)
353 1 283 5482 (Fax)

HOME PAGE: http://https://johncotter.org/

Emmanuel Eyiah-Donkor (Contact Author)

University College Dublin (UCD) - UCD School of Business ( email )

Belfield
Dublin, 4
Ireland

Valerio Potì

University College Dublin ( email )

M. Smurfit School of Business
Carysfort Avenue, Blackrock
Dublin, Co Dublin
Ireland

HOME PAGE: http://https://people.ucd.ie/valerio.poti

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