Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/60961
Authors: 
Etula, Erkko
Year of Publication: 
2010
Series/Report no.: 
Staff Report, Federal Reserve Bank of New York 406
Abstract: 
This paper shows that the risk-bearing capacity of U.S. securities brokers and dealers is a strong determinant of risk premia in commodity markets. Commodity derivatives are the principal instrument used by producers and consumers of commodities to hedge against commodity price risk. Broker-dealers play an important role in this hedging process because commodity derivatives are traded primarily over the counter. I capture the limits of arbitrage in this market in a simple asset-pricing model where producers and consumers of commodities share risk with broker-dealers who are subject to funding constraints. In equilibrium, the price of aggregate commodity risk decreases in the relative leverage of the broker-dealer sector. I estimate the model in the cross-section of commodities and find strong empirical support for its predictions. Fluctuations in risk-bearing capacity have particularly strong forecasting power for energy returns, both in sample and out of sample.
Subjects: 
Asset pricing
financial intermediaries
commodity prices
futures markets
risk appetite
JEL: 
G10
G12
G13
G24
Document Type: 
Working Paper

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