Idiosyncratic volatility in commodity futures markets: measurement and puzzle

Abstract

Purpose

This paper aims to propose an alternative method to measure idiosyncratic volatility and test whether the idiosyncratic volatility puzzle holds in commodity futures markets.

Design/methodology/approach

This paper proposes a partially new measure of idiosyncratic volatility in commodity futures markets based on the Schwartz and Smith (2000) short-term/long-term model. This model enables us to capture systematic risks of commodity futures markets in a parsimonious way.

Findings

Using a sample of futures contracts for 20 commodities from 1973 to 2022, this paper demonstrates that idiosyncratic volatility is more significant than systematic volatility in commodity futures markets, and that the idiosyncratic volatility puzzle does not hold in these markets. This paper also performs robustness tests to investigate whether the puzzle holds during subsample periods when commodity markets are more volatile and find consistent results. This study highlights the differences between commodity futures markets and equity markets and emphasizes the importance of investigating idiosyncratic volatility in commodity futures markets.

Originality/value

The contributions of this paper are threefold. First, this paper contributes to the literature by focusing on the idiosyncratic volatility of commodity futures returns. Second, this paper constructs a partially new measure of idiosyncratic volatility in commodity futures markets. Finally, this paper also contributes to the literature on the idiosyncratic volatility puzzle and demonstrates that the puzzle may not exist in commodity futures markets.

Citation

Hong, L. and Zhou, T. (2023), "Idiosyncratic volatility in commodity futures markets: measurement and puzzle", Managerial Finance, Vol. 49 No. 10, pp. 1641-1672. https://doi.org/10.1108/MF-12-2022-0589