Commodity Futures Returns and Idiosyncratic Volatility

This paper studies the relationship between idiosyncratic volatility and expected returns in commodity futures markets. Measuring idiosyncratic volatility relative to traditional pricing models that fail to account for backwardation and contango leads to the puzzling conclusion that idiosyncratic volatility is negatively priced. In sharp contrast, idiosyncratic volatility is not priced when the fundamental backwardation and contango cycle of commodity futures markets is factored in an appropriate benchmark. Further evidence suggests that the idiosyncratic volatility inferred from traditional benchmarks acts as proxy for the risk associated with contangoed contracts.