The Pricing of Geopolitical Risk in Cross-Sectional Commodity Futures Returns

<p>Based on a four-factor model, I investigate whether geopolitical risk is a pricing factor in cross-sectional commodity futures returns. By estimating the exposure of commodity futures returns on a geopolitical risk index, I find that commodities with high-risk beta generate 7.92% higher annual returns than those with low-risk beta. The results indicate that high geopolitical risk-related commodity futures contracts require extra compensation. A moving average procedure shows that the geopolitical risk beta has a regular changing pattern that cycles every 10 years, and the relative risk premium tends to be higher than average before economic recessions and to further increase during the recession periods. In addition, I find that geopolitical threats better explain the variation of commodity futures return than do geopolitical actions.</p>