The geopolitical risk premium in the commodity futures market

Daxuan Cheng, Yin Liao and Zheyao Pan

Journal of Futures Markets, 2023, vol. 43, issue 8, 1069-1090

Abstract: In this study, we investigate the geopolitical risk premium in the commodity futures market. By estimating the exposure of cross‐sectional commodity futures excess returns on a historical geopolitical risk index, we find that commodities with low‐risk betas generate 9.05% higher annual risk‐adjusted returns than those with high‐risk betas. The results indicate that low‐geopolitical‐risk‐related commodity futures contracts require extra compensation by risk‐averse investors due to hedging demand. We also explore the time‐varying characteristics of the geopolitical risk premium: It appears more pronounced during high‐geopolitical‐risk periods and before the year 2000. Finally, we exploit the subcategories of geopolitical risk and find that geopolitical threats better explain the variation of the geopolitical risk premium than do geopolitical acts, making it a main source of the geopolitical risk premium.

Date: 2023
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