Working Paper: NBER ID: w19056
Authors: James D. Hamilton; Jing Cynthia Wu
Abstract: If commercial producers or financial investors use futures contracts to hedge against commodity price risk, the arbitrageurs who take the other side of the contracts may receive compensation for their assumption of nondiversifiable risk in the form of positive expected returns from their positions. We show that this interaction can produce an affine factor structure to commodity futures prices, and develop new algorithms for estimation of such models using unbalanced data sets in which the duration of observed contracts changes with each observation. We document significant changes in oil futures risk premia since 2005, with the compensation to the long position smaller on average in more recent data. This observation is consistent with the claim that index-fund investing has become more important relative to commerical hedging in determining the structure of crude oil futures risk premia over time.
Keywords: Crude Oil Futures; Risk Premia; Hedging; Commodity Price Risk
JEL Codes: G13; G23; Q14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| hedging pressure from commodity producers and index-fund investors (Q02) | crude oil futures prices (Q47) |
| interaction between commercial producers and financial investors using futures contracts (G13) | compensation mechanism for arbitrageurs (G19) |
| compensation mechanism for arbitrageurs (G19) | affine factor structure in commodity futures prices (G13) |
| increased buying pressure from commodity-index funds (Q02) | shift in risk premium from long side to short side of futures contracts (G13) |
| significant changes in risk premia since 2005 (B26) | long positions earning negative returns when the futures curve is steep (G13) |
| evolving role of financial investors as counterparties for commercial hedgers (G19) | changes in risk premia (G19) |