Is idiosyncratic volatility priced in commodity futures markets?

•This article studies the pricing of idiosyncratic volatility in commodity futures markets.•Idiosyncratic volatility is not priced when the fundamentals of backwardation and contango are suitably factored in the pricing relationship.•It commands a negative price of risk within traditional models and then proxies for a missing risk that relates to backwardation and contango.

This article investigates the relationship between expected returns and past idiosyncratic volatility in commodity futures markets. Measuring the idiosyncratic volatility of 27 commodity futures contracts with traditional pricing models that fail to account for backwardation and contango leads to the puzzling finding that idiosyncratic volatility is significantly negatively priced cross-sectionally. However, idiosyncratic volatility is not priced when the phases of backwardation and contango are suitably factored in the pricing model. A time-series portfolio analysis similarly suggests that failing to recognize the fundamental risk associated with the inexorable phases of backwardation and contango leads to overstated profitability of the idiosyncratic volatility mimicking portfolios.