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Commodity Return Predictability: Evidence from Implied Variance, Skewness and their Risk Premia

Last Updated on 10 February, 2024 by Rejaul Karim

In the paper “Commodity Return Predictability: Evidence from Implied Variance, Skewness and their Risk Premia,” Marinela Adriana Finta and Jose Renato Haas Ornelas delve into the dynamic interplay between realized and implied variance and skewness, as well as their associated risk premia, in predicting commodities’ future returns.

Utilizing high-frequency and commodity futures option data, the study provides forward-looking estimates of these moments, enabling the computation of risk premia as the delta between implied and realized moments.

Notably, the research underscores the strong positive relationship between commodity returns and implied skewness from both cross-sectional and time series perspectives, shedding light on the considerable performance of skewness risk premia.

Furthermore, the paper illuminates the superior risk-return tradeoff exemplified by portfolios based on these moments, drawn from robust results that factor in other elements such as momentum and roll yield.

Abstract Of Paper

This paper investigates the role of realized and implied and their risk premia (variance and skewness) for commodities’ future returns. We estimate these moments from high frequency and commodity futures option data that results in forward-looking measures. Risk premia are computed as the difference between implied and realized moments. We highlight, from a cross-sectional and time series perspective, the strong positive relation between commodity returns and implied skewness. Moreover, we emphasize the high performance of skewness risk premium. Additionally, we show that their portfolios exhibit the best risk-return tradeoff. Most of our results are robust to other factors such as the momentum and roll yield.

Original paper – Download PDF

Here you can download the PDF and original paper of Commodity Return Predictability: Evidence from Implied Variance, Skewness and their Risk Premia.

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Author

Marinela Adriana Finta
Singapore Management University

Jose Renato Haas Ornelas
Banco Central do Brasil

Conclusion

In conclusion, “Commodity Return Predictability: Evidence from Implied Variance, Skewness and their Risk Premia” illuminates the pivotal role of implied skewness and its associated risk premium in the predictability of commodities’ future returns.

The study, drawing on high-frequency and commodity futures option data, underscores the robust positive relationship between commodity returns and implied skewness, both from cross-sectional and time series perspectives.

Furthermore, the research highlights the notable performance of skewness risk premium and the superior risk-return tradeoff exhibited by portfolios based on these moments.

Importantly, the paper’s findings showcase resilience against other influential factors such as momentum and roll yield, lending further credence to the significance of implied skewness and its risk premia in informing commodity forecast models.

These insights hold the potential to enhance decision-making processes within the realm of commodity trading and market analysis.

Related Reading:

Dynamic Commodity Timing Strategies

Determinants of Trader Profits in Futures Markets

FAQ

Q1: What is the main focus of the paper “Commodity Return Predictability: Evidence from Implied Variance, Skewness and their Risk Premia” by Marinela Adriana Finta and Jose Renato Haas Ornelas?

A1: The paper focuses on investigating the role of realized and implied variance and skewness, along with their associated risk premia, in predicting future returns of commodities. The study utilizes high-frequency and commodity futures option data to provide forward-looking estimates of these moments, allowing for the computation of risk premia as the difference between implied and realized moments.

Q2: What does the research reveal about the relationship between commodity returns and implied skewness, and what is emphasized regarding skewness risk premia?

A2: The research highlights a strong positive relationship between commodity returns and implied skewness, both from cross-sectional and time series perspectives. Emphasis is placed on the considerable performance of skewness risk premia, indicating its importance in predicting commodities’ future returns.

Q3: How does the paper demonstrate the superior risk-return tradeoff exhibited by portfolios based on implied variance and skewness, and what factors are considered in the robustness of these results?

A3: The paper demonstrates that portfolios based on implied variance and skewness exhibit the best risk-return tradeoff. The results remain robust even when considering other influential factors such as momentum and roll yield. This underscores the resilience and significance of implied skewness and its risk premia in informing commodity forecast models and decision-making processes within commodity trading.

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