A Model-based Commodity Risk Measure on Commodity and Stock Market Returns

Ai Jun Hou, Emmanouil Platanakis, Xiaoxia Ye, guofu Zhou

Research output: Working paper / PreprintWorking paper

Abstract

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.
Original languageEnglish
Pages1-84
Number of pages84
Publication statusIn preparation - 11 Oct 2022

Keywords

  • Commodities
  • Term structure models
  • Predictability
  • Cross-sectional asset pricing

ASJC Scopus subject areas

  • Economics, Econometrics and Finance (miscellaneous)
  • Finance

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