RDP 2017-03: Financialisation and the Term Structure of Commodity Risk Premiums 6. Conclusion

Commodities such as oil and wheat are important inputs into the real economy, and can have a significant influence on the welfare of individuals through their roles as consumption goods and as inputs into other goods. As such, it is important to understand how commodity prices, both spot and futures, are set and whether there are any distortions to these prices. To this end, this paper examines commodity risk premiums – one component of commodity futures prices – and their determinants. However, unlike the majority of the literature, we focus on the term structure of commodity risk premiums, recognising that premiums for futures contracts with different maturities could differ.

Consistent with this prior, we find evidence that commodity risk premiums are not constant across maturities, and that the shape of the commodity risk premium ‘curve’ differs across commodities and over time. This suggests information could be contained in the shape of the risk premium curve. We also empirically test the net hedging pressure theory, which has received mixed support in the empirical literature in the past. We find strong evidence of a negative relationship between NHP and risk premiums, as would be suggested by the net hedging pressure theory, when we include returns on longer-dated futures contracts. Our results also suggest that the relationship between NHP and risk premiums is more significant for longer-dated futures contract.

Having identified these premiums, we then go on to examine whether the financialisation of commodities markets has affected average risk premiums for commodities futures and, in particular, whether these effects have differed for contracts with different maturities. Using a DD approach, we find little statistical evidence that financialisation has had a significant overall effect on the ‘residual’ or idiosyncratic portion of commodity risk premiums for a broad basket of commodities. But we do find some evidence of smaller residual risk premiums for wheat, which could reflect either reduced market segmentation in wheat markets, or a secular increase in the demand for long positions. This is most evident for short-maturity commodity contracts. We also find some evidence that financialisation increased the correlation between returns on on-index commodity futures and returns on the ‘market’ portfolio, which should have increased the systematic portion of commodity risk premiums. This is more evident for longer-maturity contracts and could suggest that markets for these contracts have become more integrated.

These results should be interpreted with some caution, given the somewhat limited scope of our findings in terms of commodities and due to potential concerns regarding the data quality. Still, taken as a whole, our results suggest a more neutral interpretation of the effects of financialisation than is set out in some of the literature.