Joshua D. Woodard
Office for Futures and Options Research (OFOR)
University of Illinois at Urbana-Champaign
The motivation for investing in commodity futures dates back to at least the 1930s when John Maynard Keynes1 proposed the theory of normal backwardation. The theory of normal backwardation posits that futures markets are essentially insurance markets. Under the assumption that hedgers were primarily producers of commodities, Keynes reasoned that long speculators should earn a risk premium for taking on the spot price risk hedgers wished to shed. This view was debated extensively throughout the next four decades but was almost always addressed in an isolated, individual market context.2 The advent of Markowitz's mean-variance model and the development of Sharpe's capital asset pricing model (CAPM), however, prompted new thinking on the nature of speculative returns in commodity futures markets.
In 1973, Dusak3 challenged the conventional notion of risk premiums by applying the CAPM framework to commodity futures returns. She argued that in principle futures markets are no different than any other market for risky assets. Specifically, the portfolio approach makes no presumption as to whether absolute returns are positive, negative, or zero, but rather that the returns on any risky asset are determined by that asset's contribution to the risk-return of a large ...