Default Premiums in Commodity Markets: Theory and Evidence




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    • Johnson Graduate School of Management, Cornell University, Ithaca, NY 14853–4201, and Department of Finance and Banking, National University of Singapore, 10 Kent Ridge Crescent, Singapore 0511. We are grateful to Michael Brennan, Peter Carr, K. C. Chan, Margaret Forster, David Hirshleifer, Eric Jacquier, Robert Jarrow, Laura Kodres, Larry Lang, Joseph Lim, Francis Longstaff, Maureen O'Hara, George Emir Morgan, Paul Seguin, Seymour Smidt, Rene Stulz, Ralph Walkling, an anonymous referee, and seminar participants at Ohio State, the Cleveland Fed, National University of Singapore, Maryland, University of Southern California, Cornell, and Syracuse for helpful discussions and comments on earlier drafts. Michael Geregach, Irene Ling, Chi-June Kao, and Simon Yen provided able research assistance.


We model the effect of nonperformance risk on forward and futures pricing and look for evidence of nonperformance risk in precious metals futures prices from the “Hunt Brothers”episode. Changes in default premiums are measured and related to the sequence of events in the metals markets during this period. Results suggest first that ex ante costs of nonperformance can be a significant, priced factor in commodity markets and second that the arrival of new information is often associated with changes in these costs. The evidence has implications for both theoretical and empirical research on commodity markets.