The linkage between aggregate stock market investor sentiment and commodity futures returns

Abstract

This article investigates the predictive content of aggregate stock market investor sentiment on the returns of commodity futures. The sample consists of four subcategories: agricultural, livestock, energy and metal futures, for a total of 26 commodity futures spanning from the period 1968 to 2010. Overall, commodity futures perform better when investor sentiment is pessimistic rather than optimistic. The asymmetrical response to sentiment shocks may partially account for this difference. Cross-sectional analysis indicates a persistent negative relationship between investor sentiment and commodity futures returns, even after controlling for the effects of liquidity and open interest. Additional analysis shows that when conditional volatilities are high, the negative relationship between investor sentiment and commodity futures returns becomes more pronounced.

Keywords:

• commodity futures
• investor sentiment
• VAR-GARCH-M
• Markov regime-switching

JEL Classification:

• G10

Notes

¹ To be more specific, positive and negative values of sentiment index are defined relative to a 10-year average.

² As described in Elder (2003).

³ Following Gray (1996).