Commodity tail risk and equity risk premia

We explore the asset pricing implication of the commodity tail risk, constructed by aggregating individual commodity's exposure to left-tail realizations of systematic risks, in cross-sectional stock returns. Using Chinese data from 2005 to 2022, we find that the risk-adjusted return differential between extreme portfolios is highly significant at 1.39% per month. The economic rationale is that a high level of commodity tail risk signals adverse economic conditions, and stocks that hedge the tail risk offer a low premium. Our findings highlight the informational role of commodity futures prices and the link between commodity and equity markets in China.