Common risk factors in commodities

This article aims at establishing an understanding of the common risk factors in commodity markets, as well as their interactions with equities, currencies and interest rates. Since commodity markets often exhibit cross-sectional dependency, common risk factors exist and can be identified. By using daily data from 1995 to 2012, the econometric methodology resorts to factor modeling combined with a criterion to determine the number of factors presented in Alessi et al.(2010). The operational significance of the results is to evaluate risk-adjusted performance of portfolios allocated to commodities, and to help building cross-asset strategies. Investors can then pinpoint the correlation between any two-position taken within commodity markets, and attempt to profitably exploit the common sources of risk. In turn, it should provide the researcher with an increased understanding of the risks at work in the commodity world.