Risk Premiums in the Cross-Section of Commodity Convenience Yields

Abstract

This paper investigates risk premiums embedded in commodity convenience yields, i.e., returns on convenience-claim investments. The analysis is conducted in two steps. First, monthly convenience yields are extracted from a broad sample of commodity futures by using a three-factor model. Second, a multi-factor asset pricing model with conditional betas is estimated to determine risk premiums embedded in convenience-claim returns. The empirical analysis is carried out on monthly cross-sections of 22 commodities in the period from January 1991 to December 2011. It reveals the existence of significant premiums embedded in convenience yields for systematic risk factors typically related to other asset classes. While the predictability of the risk premiums via instrumental variables is limited, changes in conditional betas are found to forecast variations in convenience yields.