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Probability weighting in commodity futures markets

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  • Jun Yuan
  • Qi Xu
  • Ying Wang

Abstract

Probability weighting refers to the behavioral bias in which irrational investors have a propensity to overweigh small probability tail events. In this study, we empirically investigate the asset pricing implications of probability weighting in commodity markets. We find that commodities with a high probability‐weighting value significantly underperform their low‐value pairs by 11% per annum. Neither conventional commodity risk factors nor existing characteristics explain this predictability. The predictability is more pronounced when arbitrage constraints are more binding. Commodities with a high probability‐weighting value also attract excess demand from non‐commercial traders. Collectively, these findings support a prospect theory‐based explanation for the cross‐section of commodity returns.

Suggested Citation

  • Jun Yuan & Qi Xu & Ying Wang, 2023. "Probability weighting in commodity futures markets," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 43(4), pages 516-548, April.
    • Handle: RePEc:wly:jfutmk:v:43:y:2023:i:4:p:516-548
    DOI: 10.1002/fut.22400
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