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Do Investors Price Industry Risk? Evidence from Commodity Dependent Industries

Recent research has identified several industry-related patterns that standard asset pricing models cannot explain effectively. This paper investigates whether industry commodity dependence affects the cross section of stock returns, using the case of oil industry. The results show that in the period 1988-2012, a value (equally) weighted portfolio of high oil loading stocks outperforms a portfolio of low oil loading stocks by 9.45% (9.18%) in average annually. Using the Fama and French asset pricing model extended with an oil factor, we find that oil price risk is priced supporting that the investors price the risk of commodity dependence. Other factors such as size and momentum are also priced. Results suggest that investors price industry specific risks and therefore a different asset pricing model should be used.