An Anatomy of Commodity Futures Risk Premia
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What they found
The authors decompose commodity futures returns into a spot premium (compensation for exposure to the underlying commodity) and a term premium (the return from holding contracts of different maturities, which captures the shape of the curve). Using 21 commodities from 1986 to 2010, they show that spot premia are explained by a single factor based on the basis (the slope of the curve), while term premia are much smaller and require their own factors. Characteristics like basis, momentum, volatility, and inventories all predict spot premia.
What you can use
- Commodity returns come in two layers: the spot premium (is the commodity going up) and the term premium (which contract on the curve you hold); most of the action is in the first.
- The basis (backwardation versus contango) is the single most powerful characteristic for sorting commodities.
- Calendar spread trades capture the term premium, which is smaller and behaves differently from outright positions.
Caveats
Technical asset-pricing paper with factor models; not a strategy paper. Sample 1986 to 2010.
Tags: commodities, futures, risk-premium, term-structure
Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.