A Model-based Commodity Risk Measure on Commodity and Stock Market Returns
2022 University of Rochester Conference in Econometrics, Paris December Finance Meeting 2022, FMA Annual Meeting 2022, FMA-Europe 2022, EFMA 2022
82 Pages Posted: 21 Sep 2022 Last revised: 21 Nov 2022
Date Written: November 19, 2022
We propose a novel measure of the ex-ante commodity downside-risk premium (CDP) for each commodity based on a term structure model of commodity futures. Our theory-based CDP, capturing forward-looking information in the futures markets, outperforms well-known characteristics in explaining the cross-section of commodity returns. The CDP factor – the high minus low portfolio constructed from sorting CDP – has the highest Sharpe ratio among existing factors, and none of the latter can explain it, implying it has substantial new information. Moreover, various aggregations of individual commodity CDP predict future stock market returns significantly, even after controlling for major economic predictors. The link between commodities and the stock market is stronger than previously thought.
Keywords: Commodities, Term structure models, Predictability, Cross-sectional asset pricing
JEL Classification: G10, G11, G12, G13
Suggested Citation: Suggested Citation