Factor pricing in commodity futures and the role of liquidity

Abstract

This paper empirically investigates the pricing factors and their associated risk premiums of commodity futures. Existing pricing factors in equity and bond markets, including market premium and term structure, are tested in commodity futures markets. Hedging pressure in commodity futures markets and momentum effects is also considered. This study combines these factors to discuss their importance in explaining commodity future returns, while the literature has studied these factors separately. One of the important pricing factors in equity and bond markets is liquidity, but its role as a pricing factor in commodity futures markets has not yet been studied. To our knowledge, this research is the first to study liquidity as a pricing factor in commodity futures. The risk premiums of two momentum factors and speculators’ hedging pressure range from 2% to 3% per month and are greater than the risk premiums of roll yield (0.8%) and liquidity (0.5%). The result of a significant liquidity premium suggests that liquidity is priced in commodity futures.

Keywords:

• Commodity futures
• Risk premium
• Liquidity
• Momentum
• Roll yield

JEL Classifications:

• G12
• G13
• G15

Notes

¹ Momentum is an effect or a measure of the pricing factors, but momentum itself is not a real risk factor. Momentum is sometimes described as a pricing factor, but one should interpret the result with caution.