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+ The Stock Market Price of Commodity Risk November 2013 Martijn Boons, Nova School of Business and Economics Frans de Roon, Tilburg University, CentER.

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Presentation on theme: "+ The Stock Market Price of Commodity Risk November 2013 Martijn Boons, Nova School of Business and Economics Frans de Roon, Tilburg University, CentER."— Presentation transcript:

1 + The Stock Market Price of Commodity Risk November 2013 Martijn Boons, Nova School of Business and Economics Frans de Roon, Tilburg University, CentER Marta Szymanowska, Rotterdam School of Management

2 + Motivation Commodity Futures Modernization Act (CFMA) Dramatic change in size and composition of futures markets 2 TOI in 33 commodities

3 + Motivation CFMA: break point in the behavior of (institutional) investors Pre-CFMA commodity exposure position limits in futures markets commodity-related equity, physical commodities (Lewis, 2007) Post-CFMA commodity exposure commodity index investment (CII) by institutions from 6% of total open interest ( 200$ bln) in 2009 3

4 + Our goal We want to understand commodity prices as a source of risk price of this risk in the stock and commodity futures markets impact of CFMA / changing investment behavior This will allow us to shed light on a link between stock and commodity futures markets financialization of commodities stock market strategies to hedge or speculate on commodity prices 4

5 + Our Approach A model with investors exposed to commodity price risk in the spirit of Hirshleifer (1988,1989), Bessembinder and Lemmon (2002) Study the effect of position limits on demand and prices Testable implications Sort stocks on commodity beta Sort commodity futures on stock market risk Main empirical findings 1. Commodity risk is priced in stock market in the opposite way before and after CFMA 2. Stock market risk is priced in the commodity futures market post-CFMA 5

6 + The model 6

7 + The Investors problem 7

8 + Expected stock returns with commodity price risk With limits Cross-hedging demand implies a negative (positive) risk premium when φ 0) and high commodity prices are bad (good) news Without limits Risk premium determined by speculative investment in commodities If zero CAPM! 8

9 + Risk premiums in the futures market 1. With limit: Producers and Speculators only 2. Without position limits: stock market risk is priced due to presence of Investors 9

10 + Data and method: stock market All CRSP stocks, Frenchs 48 industry portfolios OIW index of 33 commodities (from CRB and FII) Robust: EW index, S&P-GSCI index Variation across commodity sectors Sorts on rolling 60 month commodity beta Mean and risk-adjusted returns (CAPM, FF3M and FFCM) of High minus Low (HLCB) portfolios Pre- versus Post-CFMA: split around December 2003 Robust Different break points Different rebalancing Fama-MacBeth cross-sectional estimates Between/within industry sort Controlling for inflation 10

11 + Stock market: pre-CFMA 11

12 + Stock market: post-CFMA 12

13 + Means and FFCM alphas 13 Pre-CFMAPost-CFMA Size quintileOne-waySize quintileOne-way OIW EWOIW EW S3BStocks48 Ind.StocksS3B 48 Ind.Stocks MeansH5.883.552.331.915.004.4512.1315.2915.10*14.85*14.5711.93 48.88*6.90*7.04*6.58*8.23*5.7712.029.974.785.645.977.33 310.56*9.44*6.32*7.04*7.84*8.25*11.078.582.083.586.625.16 210.55*11.32*9.24*9.53*10.07*8.81*9.257.913.083.876.475.07 L8.93*13.03*10.01*10.02*9.72*9.33*1.881.983.252.772.353.24 HLCB-3.04-9.47*-7.68*-8.11*-4.72*-4.8810.25*13.31*11.85*12.08*12.22*8.69 FFCMH-1.73-6.12*-5.52*-6.67*-4.75*-3.521.656.8111.30*9.82*8.60*6.23 40.69-3.23*-0.97-1.73-0.920.402.402.461.671.33-0.821.76 32.410.43-0.61-0.13-1.990.761.601.66-1.83-0.931.081.16 22.823.48*3.22*3.33*2.131.080.771.53-0.47-0.191.231.18 L2.755.59*5.88*4.99*2.122.77*-6.66*-4.67*0.36-1.08-2.01-0.09 HLCB-4.48*-11.71*-11.39*-11.66*-6.87*-6.30*8.31*11.48*10.94*10.90*10.60*6.32 * Indicates significance at the 5%-level

14 + The reversal in the commodity risk premium I 14

15 + The reversal in the commodity risk premium II 15

16 + Hedgers versus Speculators 16

17 + Commodity futures risk premiums With and without limit: a classic hedging pressure effect In both sub-periods, sorting on hedging pressure works Without limits, stock market risk is priced in the futures market Using that T=M+H, sort commodities on beta with respect to the MKT and HLCB portfolio High stock market beta commodities outperform ONLY post- CFMA, as predicted! 17 Pre-CFMAPost-CFMA HLCB MKT LowHighMKT LowHigh Low1.36%7.43%Low-2.23%8.09% High-2.25%3.83%High9.06%9.16% HH-LL2.48%HH-LL11.38% t(HH-LL) (0.55) t(HH-LL) (1.77)

18 + Conclusion Focus on the structural break in investors behavior Study a model with Investors exposed to commodity price risk Analyze the effect of position limits related to CFMA We find Commodity risk is priced in stock market in the opposite way pre- versus post-CFMA Stock market risk is priced in the commodity futures market post- CFMA Consistent with Investors seeking commodity exposure in the stock market pre-CFMA and subsequently in the commodity futures markets Stocks to hedge or speculate on commodity prices 18

19 + Within-industry sort 19 Out-of-sample test: spreads exist when using only within- industry variation in commodity beta Hedge, while keeping industry exposure constant 1980-2003 (Pre-CFMA)2004-2010 (Post-CFMA) Industries sorted on commodity beta Within-industryH432LAverageH432L MeansHLCB-3.39-6.13*-4.17-3.34-4.72-4.35*13.64*11.01*5.3819.05*9.3711.69* FFCMHLCB-6.92*-7.58*-4.37-4.86*-9.01*-6.55*13.92*9.762.1714.58*5.489.18*

20 + Industry composition of High and Low portfolio 20


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