Hostname: page-component-8448b6f56d-tj2md Total loading time: 0 Render date: 2024-04-19T16:47:18.069Z Has data issue: false hasContentIssue false
  • English
  • Français

Do Commodities Add Economic Value in Asset Allocation? New Evidence from Time-Varying Moments

Published online by Cambridge University Press:  14 February 2018

Xin Gao  and
Federico Nardari
Get access Rights & Permissions [Opens in a new window]

Abstract

We conduct a comprehensive out-of-sample assessment of the economic value adding of commodities in multiasset investment strategies that exploit the predictability of asset return moments. We find that predictability makes the inclusion of commodities profitable even when short selling and high leverage are not permitted. For instance, a mean-variance (non-mean-variance) investor with moderate risk aversion and leverage, rebalancing quarterly, would be willing to pay up to 108 (155) basis points per year after transaction cost for adding commodities to her stock, bond, and cash portfolio. Previous research had reached mixed or even opposite conclusions, especially in an out-of-sample context.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 53 , Issue 1 , February 2018 , pp. 365 - 393
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

Footnotes

1

We thank Rob Brown, Stephen Brown (the editor), David Feldman, Thijs van der Heijden, Kris Jacobs, Antonio Gargano, Lyndon Moore, Raul Susmel, Jun Tu (the referee), and seminar participants at Monash University, the University of Melbourne, and the University of New South Wales for useful comments and discussions.

References

Ang, A. Asset Management. Oxford, UK: Oxford University Press (2014).Google Scholar
Ang, A., and Bekaert, G.. “International Asset Allocation with Regime Shifts.” Review of Financial Studies, 15 (2002), 1137–1187.CrossRefGoogle Scholar
Anson, M.“Maximizing Utility with Commodity Futures Diversification.” Journal of Portfolio Management, 25 (1999), 86–94.CrossRefGoogle Scholar
Avramov, D.“Stock Return Predictability and Model Uncertainty.” Journal of Financial Economics, 64 (2002), 423–458.Google Scholar
Baker, M., and Wurgler, J.. “Investor Sentiment in the Stock Market.” Journal of Economic Perspectives, 21 (2007), 129–151.Google Scholar
Bakshi, G.; Panayotov, G.; and Skoulakis, G.. “The Baltic Dry Index as a Predictor of Global Stock Returns, Commodity Returns, and Global Economic Activity.” AFA Meetings Paper (2011).Google Scholar
Ball, C., and Torous, W.. “Stochastic Correlation across International Stock Markets.” Journal of Empirical Finance, 7 (2000), 373–388.CrossRefGoogle Scholar
Barclays Capital. “The Commodity Investor,” Research Report (2012).Google Scholar
Bates, J., and Granger, C.. “The Combination of Forecasts.” Journal of the Operational Research Society, 20 (1969), 451–468.CrossRefGoogle Scholar
Bekaert, G.; Erb, C.; Harvey, C.; and Viskanta, T.. “Distributional Characteristics of Emerging Market Returns and Asset Allocation.” Journal of Portfolio Management, 24 (1998), 102–116.Google Scholar
Belousova, J., and Dorfleitner, G.. “On the Diversification Benefits of Commodities from the Perspective of Euro Investors.” Journal of Banking & Finance, 36 (2012), 2455–2472.Google Scholar
Ben-David, I.; Franzoni, F.; and Moussawi, R.. “Hedge Fund Stock Trading in the Financial Crisis of 2007–2009.” Review of Financial Studies, 25 (2012), 1–54.Google Scholar
Bessembinder, H., and Chan, K.. “Time-Varying Risk Premia and Forecastable Returns in Futures Markets.” Journal of Financial Economics, 32 (1992), 169–193.Google Scholar
Bhardwaj, R. K., and Brooks, L. D.. “The January Anomaly: Effects of Low Share Price, Transaction Costs, and Bid-Ask Bias.” Journal of Finance, 47 (1992), 553–575.Google Scholar
Bianchi, D., and Guidolin, M.. “Can Long-Run Dynamic Optimal Strategies Outperform Fixed-Mix Portfolios? Evidence from Multiple Data Sets.” European Journal of Operational Research, 236 (2014), 160–176.Google Scholar
Billio, M.; Caporin, M.; and Gobbo, M.. “Flexible Dynamic Conditional Correlation Multivariate GARCH Models for Asset Allocation.” Applied Financial Economics Letters, 2 (2006), 123–130.CrossRefGoogle Scholar
Bodie, Z., and Rosansky, V.. “Risk and Return in Commodity Futures.” Financial Analysts Journal, 36 (1980), 27–39.Google Scholar
Brandt, M.“Portfolio Choice Problems.” Handbook of Financial Econometrics, 1 (2009), 269–336.Google Scholar
Brown, S. J.“The Portfolio Choice Problem: Comparison of Certainty Equivalence and Optimal Bayes Portfolios.” Communications in Statistics, Simulation and Computation, 7 (1978), 321–334.Google Scholar
Büyükşahin, B.; Haigh, M.; and Robe, M.. “Commodities and Equities: Ever a ‘Market of One’?” Journal of Alternative Investments, 12 (2010), 76–95.Google Scholar
Campbell, J. Y., and Shiller, R. J.. “Yield Spreads and Interest Rate Movements: A Bird’s Eye View.” Review of Economic Studies, 58 (1991), 495–514.Google Scholar
Campbell, J. Y., and Thompson, S.. “Predicting Excess Stock Returns Out of Sample: Can Anything Beat the Historical Average?” Review of Financial Studies, 21 (2008), 1509–1531.Google Scholar
Campbell, J. Y., and Viceira, L. M.. Strategic Asset Allocation: Portfolio Choice for Long-Term Investors. New York, NY: Oxford University Press (2003).Google Scholar
Cao, B.; Jayasuriya, S.; and Shambora, W.. “Holding a Commodity Futures Index Fund in a Globally Diversified Portfolio: A Placebo Effect?” Economics Bulletin, 30 (2010), 1842–1851.Google Scholar
Cappiello, L.; Engle, R.; and Sheppard, K.. “Asymmetric Dynamics in the Correlations of Global Equity and Bond Returns.” Journal of Financial Econometrics, 4 (2006), 537–572.Google Scholar
Case, B.; Yang, Y.; and Yildirim, Y.. “Dynamic Correlations among Asset Classes: REIT and Stock Returns.” Journal of Real Estate Finance and Economics, 44 (2012), 298–318.Google Scholar
Cenesizoglu, T., and Timmermann, A.. “Do Return Prediction Models Add Economic Value?” Journal of Banking & Finance, 36 (2012), 2974–2987.Google Scholar
Chaves, D.; Hsu, J.; Li, F.; and Shakernia, O.. “Risk Parity Portfolio vs. Other Asset Allocation Heuristic Portfolios.” Journal of Investing, 20 (2011), 108–118.Google Scholar
Chen, Y.-C.; Rogoff, K. S.; and Rossi, B.. “Can Exchange Rates Forecast Commodity Prices?” Quarterly Journal of Economics, 125 (2010), 1145–1194.Google Scholar
Chong, J., and Miffre, J.. “Conditional Correlation and Volatility in Commodity Futures and Traditional Asset Markets.” Journal of Alternative Investments, 12 (2010), 61–75.Google Scholar
Citigroup. “Commodities Inflection Point, Still Cyclical, But Not So Super—2014 Annual Market Outlook.” Research Report (2013).Google Scholar
Cochrane, J., and Piazzesi, M.. “Bond Risk Premia.” American Economic Review, 95 (2005), 138–160.Google Scholar
Cremers, M. K. J.“Stock Return Predictability: A Bayesian Model Selection Perspective.” Review of Financial Studies, 15 (2002), 1223–1249.Google Scholar
Daskalaki, C., and Skiadopoulos, G.. “Should Investors Include Commodities in Their Portfolios After All? New Evidence” Journal of Banking & Finance, 35 (2011), 2606–2626.CrossRefGoogle Scholar
Della Corte, P.; Sarno, L.; and Tsiakas, I.. “Volatility and Correlation Timing in Active Currency Management.” In Handbook of Exchange Rates, James, J., Marsh, I. W., and Sarno, L., eds. Hoboken, NJ: John Wiley & Sons (2012), 421–447.CrossRefGoogle Scholar
DeMiguel, V.; Garlappi, L.; and Uppal, R.. “Optimal versus Naive Diversification: How Inefficient Is the 1/N Portfolio Strategy?” Review of Financial Studies, 22 (2009), 1915–1953.Google Scholar
Eastman, A., and Lucey, B.. “Skewness and Asymmetry in Futures Returns and Volumes.” Applied Financial Economics, 18 (2008), 777–800.Google Scholar
Engle, R.“Dynamic Conditional Correlation.” Journal of Business & Economic Statistics, 20 (2002), 339–350.Google Scholar
Engle, R., and Colacito, R.. “Testing and Valuing Dynamic Correlations for Asset Allocation.” Journal of Business & Economic Statistics, 24 (2006), 238–253.CrossRefGoogle Scholar
Erb, C., and Harvey, C.. “The Strategic and Tactical Value of Commodity Futures.” Financial Analysts Journal, 62 (2006), 69–97.Google Scholar
Erb, C.; Harvey, C.; and Viskanta, T.. “Forecasting International Equity Correlations.” Financial Analysts Journal, 50 (1994), 32–45.CrossRefGoogle Scholar
Fabozzi, F. J.; Füss, R.; and Kaiser, D. G.. “Strategic and Tactical Allocation to Commodities for Retirement Savings Schemes.” In The Handbook of Commodity Investing, Nijman, T. E. and Swinkels, L. A. P., eds. Hoboken, NJ: John Wiley & Sons (2008), 522–546.Google Scholar
Fama, E., and French, K.. “Commodity Futures Prices: Some Evidence on Forecast Power, Premiums, and the Theory of Storage.” Journal of Business, 60 (1987), 55–73.Google Scholar
Farinelli, S., and Tibiletti, L.. “Sharpe Thinking in Asset Ranking with One-Sided Measures.” European Journal of Operational Research, 185 (2008), 1542–1547.Google Scholar
Fleming, J.; Kirby, C.; and Ostdiek, B.. “The Economic Value of Volatility Timing.” Journal of Finance, 56 (2001), 329–352.Google Scholar
Fleming, J.; Kirby, C.; and Ostdiek, B.. “The Economic Value of Volatility Timing Using ‘Realized’ Volatility.” Journal of Financial Economics, 67 (2003), 473–509.Google Scholar
Fortenbery, T., and Hauser, R.. “Investment Potential of Agricultural Futures Contracts.” American Journal of Agricultural Economics, 72 (1990), 721–726.Google Scholar
Galvani, V., and Plourde, A.. “Portfolio Diversification in Energy Markets.” Energy Economics, 32 (2010), 257–268.Google Scholar
Gargano, A., and Timmermann, A.. “Forecasting Commodity Price Indexes Using Macroeconomic and Financial Predictors.” International Journal of Forecasting, 30 (2014), 825–843.Google Scholar
Garlappi, L., and Skoulakis, G.. “Taylor Series Approximations to Expected Utility and Optimal Portfolio Choice.” Mathematical and Financial Economics, 5 (2011), 121–156.Google Scholar
Geman, H., and Kharoubi, C.. “WTI Crude Oil Futures in Portfolio Diversification: The Time-to-Maturity Effect.” Journal of Banking & Finance, 32 (2008), 2553–2559.Google Scholar
Goetzmann, W.; Li, L.; and Rouwenhorst, K.. “Long-Term Global Market Correlations.” Journal of Business, 78 (2005), 1–38.Google Scholar
Goh, J.; Jiang, F.; Tu, J.; and Zhou, G.. “Forecasting Government Bond Risk Premia Using Technical Indicators.” Available at http://dx.doi.org/10.2139/ssrn.1914227 (2013).Google Scholar
Gorton, G.; Hayashi, F.; and Rouwenhorst, K.. “The Fundamentals of Commodity Futures Returns.” Review of Finance, 17 (2012), 35–105.Google Scholar
Gorton, G., and Rouwenhorst, K.. “Facts and Fantasies about Commodity Futures.” Financial Analysts Journal, 62 (2006), 47–68.Google Scholar
Guidolin, M., and Timmermann, A.. “International Asset Allocation under Regime Switching, Skew, and Kurtosis Preferences.” Review of Financial Studies, 21 (2008), 889–935.Google Scholar
Harvey, C. R.; Liechty, J.; Liechty, M.; and Müller, P.. “Portfolio Selection with Higher Moments.” Quantitative Finance, 10 (2010), 469–485.CrossRefGoogle Scholar
Harvey, C. R., and Siddique, A.. “Autoregressive Conditional Skewness.” Journal of Financial and Quantitative Analysis, 34 (1999), 465–487.Google Scholar
Hong, H., and Yogo, M.. “What Does Futures Market Interest Tell Us About the Macroeconomy and Asset Prices?” Journal of Financial Economics, 105 (2012), 473–490.Google Scholar
Huang, J., and Zhong, Z.. “Time Variation in Diversification Benefits of Commodity, REITs, and TIPS.” Journal of Real Estate Finance and Economics, 46 (2013), 152–192.Google Scholar
Jensen, G.; Johnson, R.; and Mercer, J.. “Efficient Use of Commodity Futures in Diversified Portfolios.” Journal of Futures Markets, 20 (2000), 489–506.3.0.CO;2-A>CrossRefGoogle Scholar
Jensen, G.; Johnson, R.; and Mercer, J.. “Tactical Asset Allocation and Commodity Futures.” Journal of Portfolio Management, 28 (2002), 100–111.Google Scholar
Jondeau, E., and Rockinger, M.. “Optimal Portfolio Allocation under Higher Moments.” European Financial Management, 12 (2006), 29–55.Google Scholar
Jondeau, E., and Rockinger, M.. “The Impact of Shocks on Higher Moments.” Journal of Financial Econometrics, 7 (2009), 77–105.CrossRefGoogle Scholar
Jondeau, E., and Rockinger, M.. “On the Importance of Time Variability in Higher Moments for Asset Allocation.” Journal of Financial Econometrics, 10 (2012), 84–123.CrossRefGoogle Scholar
Kan, R., and Zhou, G.. “Optimal Portfolio Choice with Parameter Uncertainty.” Journal of Financial and Quantitative Analysis, 42 (2007), 621–656.Google Scholar
Lesmond, D. A.; Ogden, J. P.; and Trzcinka, C. A.. “A New Estimate of Transaction Costs.” Review of Financial Studies, 12 (1999), 1113–1141.Google Scholar
Longin, F., and Solnik, B.. “Is the Correlation in International Equity Returns Constant: 1960–1990?” Journal of International Money and Finance, 14 (1995), 3–26.Google Scholar
Ludvigson, S. C., and Ng, S.. “Macro Factors in Bond Risk Premia.” Review of Financial Studies, 22 (2009), 5027–5067.Google Scholar
Markowitz, H.“Portfolio Selection.” Journal of Finance, 7 (1952), 77–91.Google Scholar
Marquering, W., and Verbeek, M.. “The Economic Value of Predicting Stock Index Returns and Volatility.” Journal of Financial and Quantitative Analysis, 39 (2004), 407–429.Google Scholar
Moskowitz, T.“An Analysis of Covariance Risk and Pricing Anomalies.” Review of Financial Studies, 16 (2003), 417–457.CrossRefGoogle Scholar
Neely, C. J.; Rapach, D. E.; Tu, J.; and Zhou, G.. “Forecasting the Equity Risk Premium: The Role of Technical Indicators.” Management Science, 60 (2014), 1772–1791.Google Scholar
Patton, A.“On the Out-of-Sample Importance of Skewness and Asymmetric Dependence for Asset Allocation.” Journal of Financial Econometrics, 2 (2004), 130–168.Google Scholar
Pettenuzzo, D.; Timmermann, A.; and Valkanov, R.. “Forecasting Stock Returns under Economic Constraints.” Journal of Financial Economics, 114 (2014), 517–553.Google Scholar
Rapach, D. E.; Strauss, J. K.; and Zhou, G.. “Out-of-Sample Equity Premium Prediction: Combination Forecasts and Links to the Real Economy.” Review of Financial Studies, 23 (2010), 821–862.Google Scholar
Stoll, H. R., and Whaley, R. E.. “Transaction Costs and the Small Firm Effect.” Journal of Financial Economics, 12 (1983), 57–79.Google Scholar
Strongin, S., and Petsch, M.. “Asset Returns and the Economic Environment.” Research Report, Goldman Sachs (1996).Google Scholar
Timmermann, A.“Forecast Combinations.” Handbook of Economic Forecasting, 1 (2006), 135–196.Google Scholar
Tu, J., and Zhou, G.. “Incorporating Economic Objectives into Bayesian Priors: Portfolio Choice under Parameter Uncertainty.” Journal of Financial and Quantitative Analysis, 45 (2010), 959–986.Google Scholar
Vrugt, E. B.; Bauer, R.; Molenaar, R.; and Steenkamp, T.. “Dynamic Commodity Timing Strategies.” Available at http://dx.doi.org/10.2139/ssrn.581423 (2009).Google Scholar
Welch, I., and Goyal, A.. “A Comprehensive Look at the Empirical Performance of Equity Premium Prediction.” Review of Financial Studies, 21 (2008), 1455–1508.Google Scholar
You, L., and Daigler, R.. “Using Four-Moment Tail Risk to Examine Financial and Commodity Instrument Diversification.” Financial Review, 45 (2010), 1101–1123.Google Scholar
You, L., and Daigler, R.. “A Markowitz Optimization of Commodity Futures Portfolios.” Journal of Futures Markets, 33 (2013), 343–368.Google Scholar
Supplementary material: File

Gao and Nardari supplementary material

Gao and Nardari supplementary material 1

Download Gao and Nardari supplementary material(File)
File 135.7 KB