AI Commodities L3 Flashcards
What are the main theories explaining futures risk premium
normal backwardation
theory of storage
systematic risk CAPM
Which determinants of commodity futures risk premier are important empirically
Theory of storage:
- convenience yield (support yes in data)
Theory of normal backwardation
- speculation and hedging pressure (no strong support)
Other systematic risk factors
- momentum (some evidence)
Why financialization can have an influence on our understanding of commodity risk premier?
- sudden increase in certain types of investors (speculative); flooded commodities market
-
What is the representative return of commodity futures?
- equally weighted average (gives a different picture of the market; distortion) because small commodities for example have the same weight as large ones)
- open interest weighted (closer to valuated index; tells you where there is more liquidation)
Why past returns might not be the best forecast of future returns?
- Changes in investment opportunities
- Time-varying weights in the index
- Roll returns
- Changes in diversification benefits (financialization has changed correlation to stocks for example)
downward sloping (futures curve)
backwardation
upward sloping
contango
excess return
spot return plus roll return(big impact)
How to invest?
Theory of Normal Backwardation
- long only when hedgers are net short. But short in futures when hedgers are net long. trading strategy
Theory of Storage
- Long low inventories and short high inventories
Systematic Risk
- Basis (can be negative or positive depending on literature futures minus spot is what we should use); Momentum; Hedging inflation (sell which are negatively exposed to inflation), Currently hedging
Strategic Allocation
Tactical allocation: basis (term-structured)
- sort commodities based no bases (buy low bases and sell high bases)
- either time series (Table 12) or cross sectional strategy (Table 13)
backwardation (upward sloping) and long position (slide 5)
is good when you roll and are long position; short position would reverse the whole picture
contango (downward sloping) and long position
is bad when you roll over and are in the long position
Tactical allocation: momentum
- holds across different markets, also in commodities
- it is not sure why this effect occurs (may be compensation for extreme crashes;
- combination of time-series and cross section (momentum works on both and has a low correlation)
Are the signals (basis, momentum) independent sources of return?
- not all of them are different
- winners (momentum) tend to be backwardated and losers contangoed
- winners tend to be commodities with low inventories and losers with high
- basis factor captures momentum, volatility…
Conclusion
You have to be careful extrapolating past returns in the future
- past average index does not include new asset classes
- financialization has affected the correlation to stock market
- average return may be significant but not representative of an asset class (the assets with high returns may have low liquidity)
- more than 3% on commodities than yes then decide on tactical allocation (which class to chose that predicts next return. Signal is base, momentum,, but hedging pressure does not really work. Then long short strategies. (Combine strategies or not, be creative)
