Freight Risk Premium in Commodity Futures: Evidence from China

This article investigates the freight risk premium effect on commodity futures returns in China from both theoretical and empirical perspectives. Extending the normal backwardation theory, we incorporate freight rate uncertainty into the cost-of-carry model. This uncertainty is further argued to shift the equilibrium of hedging pressure and exert a potential effect on commodity futures returns. Employing the freight risk premium model, our empirical results show that commodity futures exposed to higher freight risk generate significantly higher returns after controlling for fundamental and asset pricing factors. Moreover, to evaluate the profitability of the freight risk premium, we conduct univariate portfolio analysis and document a significantly positive freight risk premium in cross-sectional returns. By incorporating asymmetric investor behaviors, risk-averse investors characterized by low lottery preference and high regret aversion strengthen this positive freight risk premium. The premium remains robust after controlling for additional pricing factors, accounting for crisis periods and macroeconomic uncertainty shocks. Overall, our findings confirm that the freight risk premium is positively priced in the cross section of Chinese commodity futures returns and risk-averse investors amplify this positive risk premium effect.