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The Fundamentals of Commodity Futures Returns

Last Updated on 10 February, 2024 by Rejaul Karim

The research paper “The Fundamentals of Commodity Futures Returns” by Gary B. Gorton, Fumio Hayashi, and K. Geert Rouwenhorst, offers a comprehensive analysis of the dynamics of commodity futures risk premiums. Highlighting the variation of risk premiums across commodities and over time, the study underscores the pivotal influence of physical inventories.

Notably, the convenience yield is depicted as a non-linear function of inventories, shedding light on the informative nature of price measures like futures basis, prior futures and spot returns, and spot price volatilities in reflecting the inventory state. By employing a dataset spanning 31 commodity futures and physical inventories between 1971 and 2010, the authors substantiate these theoretical predictions.

Remarkably, the study also delves into the positions of futures market participants concerning returns and inventory state, ultimately revealing intriguing insights while finding no predictive evidence of risk premiums on commodity futures.

Abstract Of Paper

Commodity futures risk premiums vary across commodities and over time depending on the level of physical inventories. The convenience yield is a decreasing, non-linear function of inventories. Price measures, such as the futures basis, prior futures returns, prior spot returns, and spot price volatilities reflect the state of inventories and are informative about commodity futures risk premiums. We verify these theoretical predictions using a comprehensive dataset on 31 commodity futures and physical inventories between 1971 and 2010. While the positions of participants in futures markets vary with both returns and the state of inventories, we find no evidence that they predict risk premiums on commodity futures.

Original paper – Download PDF

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Author

Gary B. Gorton
Yale School of Management; National Bureau of Economic Research (NBER); Yale University – Yale Program on Financial Stability

Fumio Hayashi
National Graduate Institute for Policy Studies; GRIPS

K. Geert Rouwenhorst
Yale School of Management – International Center for Finance

Conclusion

In conclusion, “The Fundamentals of Commodity Futures Returns” by Gary B. Gorton, Fumio Hayashi, and K. Geert Rouwenhorst presents a profound understanding of commodity futures risk premiums, with a focus on their variability across commodities and over time in response to physical inventories.

The study demonstrates the decreasing, non-linear relationship of the convenience yield with inventories, shedding light on the informative nature of price measures such as the futures basis, prior futures and spot returns, and spot price volatilities in depicting the state of inventories.

Utilizing a comprehensive dataset spanning 31 commodity futures and physical inventories between 1971 and 2010, the authors validate these theoretical predictions.

Furthermore, the examination of participants’ positions in futures markets in relation to returns and inventory state yields insightful findings, while notably indicating the absence of predictive evidence for risk premiums on commodity futures.

Related Reading:

Predicting Commodity-Futures Basis Factor Return by Basis Spread

Carry Trades and Tail Risk: Evidence from Commodity Markets

FAQ

Q1: What is the main focus of “The Fundamentals of Commodity Futures Returns” by Gorton, Hayashi, and Rouwenhorst?

The paper primarily focuses on comprehensively analyzing the dynamics of commodity futures risk premiums, emphasizing the variation of risk premiums across commodities and over time. It delves into the pivotal influence of physical inventories on these risk premiums and explores the non-linear relationship of the convenience yield with inventories.

Q2: How does the study contribute to understanding the informative nature of certain price measures in reflecting the state of inventories?

The study highlights that price measures such as the futures basis, prior futures returns, prior spot returns, and spot price volatilities are informative about commodity futures risk premiums. It demonstrates how these measures reflect the state of inventories, supporting theoretical predictions.

Q3: What insights does the paper provide regarding the positions of futures market participants and their relation to returns and inventory state?

The paper examines the positions of participants in futures markets concerning returns and the state of inventories. While the positions of participants vary with both returns and inventory state, the study reveals that there is no predictive evidence that these positions can forecast risk premiums on commodity futures.

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