Diversification benefits of commodity futures
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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.
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