Commodity Futures Return Predictability and Intertemporal Asset Pricing

John Cotter, Emmanuel Eyiah-Donkor and Valerio Potì

No 202011, Working Papers from Geary Institute, University College Dublin

Abstract: We find out-of-sample predictability of commodity futures excess returns using forecast combinations 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 significantly positive predictive power for future economic activity. Two-factor models featuring innovations in each of the combination forecasts and the market factor explain a substantial proportion of the cross-sectional variation of commodity and equity returns. The associated positive risk prices are consistent with the Intertemporal Capital Asset Pricing Model (ICAPM) of Merton (1973), given how the predictors forecast an increase in future economic activity in the time-series. Overall, combination fore- casts act as state variables within the ICAPM, thus resurrecting a central role for macroeconomic risk in determining expected returns.

Keywords: Commodity futures returns; Predictability; Asset allocation; Macroeconomic risk; Intertemporal pricing (search for similar items in EconPapers)
JEL-codes: G10 G12 G15 (search for similar items in EconPapers)
Pages: 55 pages
Date: 2020-11-12
New Economics Papers: this item is included in nep-fmk, nep-for and nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: Commodity futures return predictability and intertemporal asset pricing (2023)
Working Paper: Commodity futures return predictability and intertemporal asset pricing (2023)
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Persistent link: https://EconPapers.repec.org/RePEc:ucd:wpaper:202011

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