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Unformatted text preview: Commodity Market Interest and Asset Return Predictability ∗ Harrison Hong † Motohiro Yogo ‡ March 25, 2010 Abstract We establish several new findings on the relation between open interest in commod- ity markets and asset returns. High commodity market activity, as measured by high open-interest growth, predicts high commodity returns and low bond returns. Open- interest growth is a more powerful and robust predictor of commodity returns than other known predictors such as the short rate, the yield spread, the basis, and hedg- ing pressure. Although positively correlated with commodity returns, open-interest growth contains information for future asset returns beyond contemporaneous com- modity prices. Open-interest growth also predicts changes in inﬂation and inﬂation expectations. These findings suggest that open-interest growth contains information about future inﬂation that gets priced into commodity and bond markets with delay. Our findings are consistent with recent theories of gradual information diffusion and have implications for macroeconomic forecasting models. ∗ This paper subsumes our earlier work titled “Digging into Commodities”. For comments and discus- sions, we thank Erkko Etula, Hong Liu, David Robinson, Nikolai Roussanov, Allan Timmermann, and seminar participants at Boston College, Centre de Recherche en Economie et Statistique, Dartmouth Col- lege, Federal Reserve Bank of Chicago, Fordham University, Imperial College London, Ohio State University, PanAgora Asset Management, Stockholm School of Economics, University of California San Diego, Univer- sity of Minnesota, University of Pennsylvania, University of Southern California, University of Texas at Austin, Washington University in St. Louis, the 2008 Economic Research Initiatives at Duke Conference on Identification Issues in Economics, and the 2010 Annual Meeting of the American Finance Association. We thank Jennifer Kwok, Hui Fang, Yupeng Liu, James Luo, Thien Nguyen, and Elizabeth So for research assistance. Hong acknowledges a grant from the National Science Foundation. Yogo acknowledges a grant from the Rodney L. White Center for Financial Research at the University of Pennsylvania. † Princeton University and NBER (e-mail: [email protected]) ‡ University of Pennsylvania and NBER (e-mail: [email protected]) 1. Introduction We analyze how open interest in commodity markets is related to commodity and bond returns. Our analysis is motivated by the recent volatility in commodity prices and the renewed interest in the behavior of these markets, which have not been seen since the energy crisis of the 1970s. Once largely ignored by the investment community, commodities have emerged as an important asset class. By some estimates, index investment in this asset class increased from $13 billion at the end of 2003 to $317 billion in July 2008, just prior to the financial crisis (Masters and White, 2008). During the same period, the inﬂux of new investors led to elevated levels of activity as measured by open interest in commodity futures,...
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This note was uploaded on 10/26/2010 for the course JOHNSON 6730 taught by Professor Georgegao during the Fall '10 term at Cornell.
- Fall '10