Diversification Benefits Of Commodities Research Articles

Commodity financialization and sector ETFs: Evidence from crude oil futures

We investigate the diversification benefits of energy assets in the setting of commodity financialization using data on crude oil futures and Sector ETFs (SPDRs). Correlations between commodities and financial assets increased during the post-Commodity Futures Modernization Act (CFMA)/commodity bull cycle period, resulting in lower benefits of diversification. However, we find that conditional correlations between crude oil futures and sector ETFs meaningfully increased only since the 2008–09 financial crisis. The results therefore suggest that the financial crisis, rather than CFMA regulation, explains changes in the diversification benefits of commodities. Moreover, we find that oil futures returns are less correlated with SPDRs than with the S&P index. Thus, energy futures, and crude oil in particular, offer the potential for diversification benefits in sector-style investing.

Diversification benefits of commodities: A stochastic dominance efficiency approach

Abstract We revisit the question whether commodities should be included in investors’ portfolios. We employ for the first time a stochastic dominance efficiency (SDE) approach to construct optimal portfolios with and without commodities and we evaluate their comparative performance. SDE circumvents the necessity to posit a specific utility function to describe investor’s preferences and it does not impose distributional assumptions on asset returns. We find that commodities provide diversification benefits both in- and out-of-sample. This evidence is stronger when commodity indices which mimic dynamic commodity trading strategies are used. We explain our results by documenting that commodity markets are segmented from the equity and bond markets.

Portfolio Optimization of Commodity Futures with Seasonal Components and Higher Moments

We investigate the diversification benefits of combining commodities with a traditional equity portfolio, while considering higher order statistical moments and seasonality. The literature suggests that the in-sample diversification benefits of commodities in portfolio optimization are not preserved out-of-sample. We provide an extensive in-sample and out-of-sample analysis with ten commodities and a stock index using the classical tangency mean-variance model and the maximum Omega ratio model. We show that seasonality in commodity returns should be considered, and leads to significant excess return and increase in Sharpe ratio.

A Conditional Assessment of the RelationshipsBetween Commodity and Equity Indexes

This study models the conditional relationships between the Goldman Sachs Total Return Commodity Index and Sub-Indexes and the S&P 500 index from January 1991 through June 2011 within a bivariate GARCH framework that uses instruments to model time-varying conditional correlations. The results indicate the presence of important spillovers between the conditional means and volatilities of commodity and equity index returns. The findings also indicate that conditional correlations increase from roughly zero to about 0.4 during the sample period, consistent with an increased integration of commodity and equity markets. The results also indicate that conditional correlations rise when the conditional volatility of equity returns increases and when business cycle conditions deteriorate. The greater integration of these markets is also reflected in the increase of conditional betas from around zero to roughly 0.6 over the sample period. Overall, the results indicate that while the diversification benefits of commodities diminished over the sample period, the estimated conditional correlations remain low enough for commodities to provide meaningful diversification benefits to equity investors.

On the diversification benefits of commodities from the perspective of euro investors

This paper investigates the diversification contribution of several commodities to a portfolio of traditional assets from the perspective of a euro investor. The approach applied in our analysis has high informational content as it differentiates between the sources of the diversification benefits in a statistically significant way. The results indicate that the diversification contribution varies greatly amongst the different commodities. Industrial metals, agriculturals and livestock contribute to the reduction of risk, while energy and precious metals contribute to both the reduction of the level of risk and to the improvement of return. The differentiation between bull and bear markets reveals that investors can enhance the portfolio performance by changing exposure into individual commodities. Investors can benefit from the diversification gains through financial instruments as the diversification gains hold both in the sample of physical commodity and commodity futures. Overall, the results confirm that commodities are valuable investments from the perspective of diversification.

Diversification benefits of commodity futures

The finance literature seems to be in support of the diversification benefits of adding commodity futures to an existing portfolio. Yet no empirical work has been performed to test whether the benefits are indeed statistically significant. This paper addresses several unresolved issues concerning the potential diversification benefits of commodities. First, we attempt to ascertain whether the alleged diversification benefits exist and are statistically significant. Second, to what extent are the diversification benefits unique to US investors? Would investors of a resource-based economy like Canada also benefit from adding commodities to their portfolios? Third, recent studies indicate that correlations among international equity returns are higher during bear markets than during bull markets. This type of regime-switching correlation behavior will mean lower diversification benefits from international investments when investors face a bearish environment at home. Do commodity futures display the same type of regime-switching behavior? To what extent do commodity futures offer real diversification benefits that are robust over time and across regimes? Finally, commodities may appear to be an asset for the more adventurous investors with higher risk tolerance. We want to know what type of investors should hold commodities. We demonstrate that the diversification benefit of commodities is a far more complex phenomenon than often understood in the finance literature.

The Diversification Benefits of Commodities and Real Estate in Alternative Monetary Conditions

Previous research has shown that returns (and variability of returns) to traditional asset classes are significantly influenced by Federal Reserve monetary policy. Unfortunately, while providing evidence that returns from traditional asset classes are higher and less volatile during expansive monetary policy periods, previous research has not identified asset classes that have attractive return patterns in restrictive monetary policy periods. This analysis extends that research into broad alternative investment classes including several real estate and commodity indexes. The results indicate that commodity futures provide attractive return patterns while real estate offers little diversification benefits for investors with traditional stock and bond portfolios. Both commodity and real estate volatility patterns are found to be similar to traditional asset classes—higher volatility in restrictive monetary policy periods.