Do Sectors Matter for Commodity Pricing?

Abstract

We investigate how commodity sectors shape risk premiums by decomposing characteristics into sector-wide and sector-adjusted components. Unadjusted characteristics mask sector exposures that significantly influence pricing, though their impact varies across characteristics. We identify a stochastic discount factor comprising one dominant factor and up to six weaker factors, a structure robust across decomposition methods. However, removing sector components amplifies the existing wedge between observable risk factors and test assets. Our findings underscore sector exposures as a critical yet understudied mechanism for explaining cross-sectional variation in commodity risk premiums, with possibly important implications for portfolio construction and factor investing.

Keywords: Asset Pricing, Commodity Markets, Factor Investing, Commodity Sectors, Factor Models, Characteristic-Managed Portfolios.