A Tale of Two Premiums: The Role of Hedgers and Speculators in Commodity Futures Markets (Kang et al. (2020))

A Tale of Two Premiums: The Role of Hedgers and Speculators in Commodity Futures Markets

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What they found

Using weekly CFTC positioning data on 26 commodities from 1994 to 2013, the authors reconcile two conflicting stories about who earns futures risk premia. Over long horizons, commercial hedgers pay speculators a premium (the hedging-pressure story). But over short horizons (weeks), the relationship reverses: commercials act as liquidity providers to speculators who trade impatiently, and commercials' short-term position changes predict positive returns while speculators' predict negative. Both premia exist, at different horizons, and the short-term liquidity premium is economically large.

See it drawn

Original diagrams for the ideas on this page. Illustrative, not real market data.

The bid-ask spread. Buy orders sit below, sell orders above, and the gap between the best bid (50.01) and best ask (50.04) is the spread you pay to cross. Bar length shows the size resting at each price.

What you can use

Speculators are paid for bearing hedgers' risk over months, but they pay commercials a liquidity premium over weeks by trading impatiently.
Fading recent speculator position changes, or following recent commercial position changes, has historically worked at short horizons.
Reading the COT report requires knowing which horizon you care about; the same data gives opposite signals at different horizons.

Caveats

CFTC classifications of 'commercial' and 'non-commercial' are imperfect and some large traders are misclassified. Sample ends 2013. Technical.

Tags: commodities, futures, commitments-of-traders, liquidity

Summaries are our own reading of the paper, not the authors' words. Educational only, not advice. Discuss it in Book Club.