Commodity futures return predictability and intertemporal asset pricing

John Cotter, Emmanuel Eyiah-Donkor and Valerio Potì

Journal of Commodity Markets, 2023, vol. 31, issue C

Abstract: We find out-of-sample predictability of commodity futures excess returns using combination forecasts of 28 potential predictors. Such gains in forecast accuracy translate into economically significant improvements in certainty equivalent returns and Sharpe ratios for a mean–variance investor. Commodity return forecasts are closely linked to the real economy. Return predictability is countercyclical, and the combination forecasts of commodity returns have significant predictive power for future economic activity. Two-factor models featuring the market factor and the innovations in each of the combination forecasts explain a substantial proportion of the cross-sectional variation of both commodity and equity returns. The associated positive risk premiums are consistent with Merton’s (1973) intertemporal capital asset pricing model (ICAPM), given how the combination forecasts predict an increase in future economic activity and a decline in stock market volatility in the time-series. Overall, combination forecasts act as state variables within the ICAPM, thus resurrecting a central role for macroeconomic risk in determining expected returns on commodities.

Keywords: Commodity futures return predictability; Out-of-sample forecasts; Asset allocation; Business cycle; Intertemporal asset pricing (search for similar items in EconPapers)
JEL-codes: G10 G11 G12 G13 G17 (search for similar items in EconPapers)
Date: 2023
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Working Paper: Commodity futures return predictability and intertemporal asset pricing (2023)
Working Paper: Commodity Futures Return Predictability and Intertemporal Asset Pricing (2020)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jocoma:v:31:y:2023:i:c:s2405851322000460

DOI: 10.1016/j.jcomm.2022.100289

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