On the role of commodity futures in portfolio diversification

Date
2021-09-20
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Source Title
International Federation of Operational Research Societies
Print ISSN
0969-6016
Electronic ISSN
1475-3995
Publisher
John Wiley and Sons Inc
Volume
30
Issue
Pages
2374 - 2394
Language
en
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Abstract

The last two decades have witnessed major financial crises that led investors to seek alternative assets and investment strategies to reduce their portfolio risk. In this article, we provide information on the role of commodity futures in designing portfolios and managing risk based on an appealing operational framework. Using more than 20 years of sample data, we first investigate the conditional mean and volatility dynamics of equity and commodity futures markets within a dynamic conditional correlation model setup. We then form alternative equity-commodity futures portfolios by changing the weights of commodity futures and examine if the diversified commodity-equity portfolios perform superior to the all-equity portfolios and four well-known investment strategies that suit most practitioners. Stochastic dominance approach shows that including commodity futures in diversified portfolios does not always improve the risk-return performance, except for gold in some particular portfolio setups. Accordingly, commodity assets have behaved like financial assets (stocks) and tend to be driven by the same pricing factors in general, which reduces the benefits of diversification.

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Published Version (Please cite this version)