Understanding the Sources of Risk Underlying the Cross Section of Commodity Returns

We show that a model featuring an average commodity factor, a carry factor, and a momentum factor is capable of describing the cross-sectional variation of commodity returns. More parsimonious one- and two-factor models that feature only the average and/or carry factors are rejected. To provide an economic interpretation, we show that innovations in global equity volatility can price portfolios formed on carry, while innovations in a commodity-based measure of speculative activity can price portfolios formed on momentum. Finally, we characterize the relation between the factors and the investment opportunity set. Data and the Internet appendix are available at https://doi.org/10.1287/mnsc.2017.2840 This paper was accepted by Neng Wang, finance.