Probability weighting in commodity futures markets

Jun Yuan, Qi Xu and Ying Wang

Journal of Futures Markets, 2023, vol. 43, issue 4, 516-548

Abstract: Probability weighting refers to the behavioral bias in which irrational investors have a propensity to overweigh small probability tail events. In this study, we empirically investigate the asset pricing implications of probability weighting in commodity markets. We find that commodities with a high probability‐weighting value significantly underperform their low‐value pairs by 11% per annum. Neither conventional commodity risk factors nor existing characteristics explain this predictability. The predictability is more pronounced when arbitrage constraints are more binding. Commodities with a high probability‐weighting value also attract excess demand from non‐commercial traders. Collectively, these findings support a prospect theory‐based explanation for the cross‐section of commodity returns.

Date: 2023
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https://doi.org/10.1002/fut.22400

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Persistent link: https://EconPapers.repec.org/RePEc:wly:jfutmk:v:43:y:2023:i:4:p:516-548

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