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The Price of Commodity Risk in Stock and Futures Markets

Last Updated on 10 February, 2024 by Rejaul Karim

The Price of Commodity Risk in Stock and Futures Markets,” a research paper by Martijn Boons, Frans de Roon, and Marta Szymanowska, delves into the role of commodity risk in the cross-section of US stock returns.

The authors observe a shift in investor behavior as the financialization of commodities leads to investors hedging commodity price risk primarily through commodity index investments in the futures market, instead of gaining exposure via the stock market, as was common practice previously.

Consequently, the annualized average returns of high-minus-low commodity beta stocks exhibit a marked evolution, moving from a negative 8% pre-financialization to a positive 11% post-financialization.

This study also highlights the increasing participation of stock market investors in commodity futures markets, which leads to stock market risk being priced into the cross-section of commodity futures returns.

Abstract Of Paper

We find that commodity risk is priced in the cross-section of US stock returns. Following the financialization of commodities, investors hedge commodity price risk directly in the futures market, primarily via commodity index investments, whereas before they gained commodity exposure mainly via the stock market. As a result, we find that the annualized average returns of high-minus-low commodity beta stocks change from -8% pre-financialization to 11% post-financialization. As stock market investors increasingly participate in commodity futures markets, stock market risk is also priced in the cross-section of commodity futures returns.

Original paper – Download PDF

Here you can download the PDF and original paper of The Price of Commodity Risk in Stock and Futures Markets.

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Author

Martijn Boons
Tilburg University

Frans de Roon
Tilburg University – Department of Finance

Marta Szymanowska
Erasmus University Rotterdam (EUR) – Department of Finance; Erasmus Research Institute of Management (ERIM)

Conclusion

In conclusion, the research paper “The Price of Commodity Risk in Stock and Futures Markets” by Martijn Boons, Frans de Roon, and Marta Szymanowska uncovers the impact of commodity risk on the cross-section of US stock returns.

The study emphasizes the transformation in investor behavior due to the financialization of commodities, with investors increasingly hedging commodity price risk directly in the futures market via commodity index investments. This shift has led to a notable change in the annualized average returns of high-minus-low commodity beta stocks, from -8% pre-financialization to 11% post-financialization.

Moreover, the growing participation of stock market investors in commodity futures markets results in stock market risk being priced into the cross-section of commodity futures returns, shedding light on the evolving relationship between commodities and financial markets.

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FAQ

Q1: What is the central focus of the research paper regarding commodity risk and its influence on US stock returns?

The research paper investigates the pricing of commodity risk in the cross-section of US stock returns. It explores how the financialization of commodities has led to a shift in investor behavior in terms of hedging commodity price risk, impacting the returns of stocks with commodity exposure.

Q2: How has the behavior of investors changed in response to the financialization of commodities, and what impact does it have on stock returns?

The authors observe a change in investor behavior, where investors now prefer to hedge commodity price risk directly in the futures market, particularly through commodity index investments. This contrasts with the previous practice of gaining commodity exposure mainly through the stock market. The shift is associated with a notable evolution in the annualized average returns of high-minus-low commodity beta stocks.

Q3: What is the observed evolution in the annualized average returns of high-minus-low commodity beta stocks, and what does it signify?

The study finds that the annualized average returns of high-minus-low commodity beta stocks experienced a marked evolution. Pre-financialization, these returns were -8%, and post-financialization, they changed to a positive 11%. This evolution signifies a significant transformation in the risk-return dynamics for stocks with commodity risk exposure.

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