An Anatomy Of Commodity Futures Risk Premia:Empirical Evidence From Chinese Commodity Futures Market

Futures contracts are zero-cost securities, that is, they do not require an initial investment. Hence, expected futures returns consist only of risk premia.We identify two types of risk premia in commodity futures returns:spot premia related to the risk in the underlying commodity, and term premia related to changes in the basis. Using different strategies, we isolate these two types of risk premia.Sorting on the variables such as futures basis results in sizeable spot premia between11.26%and26.37%per annum and term premia between2.91%and4.28%.The spot premia is decreasing as the futures basis increasing while the term premia is increasing as the futures basis increasing. Sorting on open interest, we find only term premia show monotonic pattern across the sorts, and we cannot find any monotonic pattern across the sorts when sorted on liquidity.We show that two factors, the market factor and the high-minus-low portfolio from basis sorts can explain the cross-section of spot premia. Only a single basis factor, the high-minus-low portfolio from basis sorts is needed to explain the term premia. As for single commodity futures, we find that that spot premia can be explained by marker factor and basis high-minus-low factor and only a single basis factor is needed to explain the term premia.