The Stock Market Price of Commodity Risk



Commodity prices are a risk factor that directly influences inflation for consumers as well as input and output prices for firms. We sort stocks according to their beta with respect to a broad commodity index and find a significant stock market price of commodity risk. The risk-adjusted returns on low commodity beta stocks versus high commodity betas stocks differ by about 8.5 percent to 11.5% per annum before 2003 and reverses to around -11% after 2003. We attribute this change in the sign of the risk premium to the entrance of financial traders into the commodity markets that followed the Commodity Futures Modernization Act. In a simple model in which investors care about an exogenous commodity risk factor, a switch from hedging the commodity risk on the stock market to hedging it directly in the commodity market easily leads to the observed change of the sign of the risk premium. Our results imply that the commodity factor is a separate additional risk factor in stock returns, not replacing the traditional Fama-French-Carhart factors. We argue that the commodity risk premium is likely to be a hedging premium for inflation.
Contact information:
Sebastian Gryglewicz
The Brown Bag Seminars are sponsored by ERIM.