Commodity Index Risk Premium

Abstract

Increasingly commodities have become an asset class in a process called financialization. Many institutional investors, looking for ways to expand their diversification opportunities, are holding positions in a commodity futures index and use them as a performance benchmark. Thus, institutional commodity holdings in commodities has expanded significantly.In this paper we estimate the risk premium of a commodity index using analyst’s forecasts and futures prices of each of the commodities included in the index. We estimate futures and expected spot price curves using a no-arbitrage multifactor stochastic pricing model and a Kalman Filter. The model includes time-varying risk premia thus allowing for the exploration of macro variables that could explain their time variation for each family of commodities.The proposed model has already shown to be effective for single commodities, such as oil and copper, but this paper extends its use to analyze indices of the four main commodity sectors: energy, industrial metals, precious metals and agriculture, as well as a global portfolio that mimics the S&P GSCI Index. This allows for a better understanding of how some macro variables affect different commodity sectors providing useful information for institutional investors of a commodity index.