The aim of the Chicago-based CME Group "Exploring the Commodity Futures Risk Premium: Implications for Asset Allocation and Regulation" strategic research project at EDHEC-Risk Institute is to explore the conditional correlations between the commodity risk premium and the returns of traditional assets over the long term to examine the diversification and extreme-risk hedging potential of commodity futures as an asset class.
The project will also look at the possible influence of long-short speculators and long-only index traders on commodity markets to bring research-based facts to the current debate on the link between commodity market “financialisation” and price formation.
The project is under the leadership of Joëlle Miffre, Professor of Finance at EDHEC Business School, and Member of EDHEC-Risk Institute. The research will build on previous work conducted by Professor Miffre which showed that a long-short dynamic approach based on the positions of hedgers and speculators and taking into account backwardation and contango was particularly apt at capturing the hedging pressure-based commodity futures risk premium.
The work will be overseen by a joint CME Group/EDHEC Risk Institute—Asia steering committee.
Long-Short Commodity Investing: Implications for Portfolio Risk and Market Regulation
This publication examines commodity futures investment over the last ten years to shed new academic evidence on the performance of passive as well as active commodity investment and their conditional volatility and conditional correlations with traditional assets. It also investigates whether the increased participation of index and long-short investors on commodity futures markets has had an impact on the volatility of prices or the traditional benefits of commodities as an asset class.
The research results confirm the relevance of commodity futures investment and document the benefits of adopting long-short strategies in terms of risk-adjusted performance, diversification and extreme-risk hedging. They find no support for the hypothesis that investors have destabilised commodity markets by increasing volatility or co-movements between the prices of commodity futures investments and those of traditional assets. This holds true whether investors go long-only or long-short and whether they are defined broadly or approached as non-commercial traders or professional money managers. [Press release announcing the publication of the research: 25/10/11]
Capturing the Risk Premium of Commodity Futures: The Role of Hedging Pressure
Devraj Basu, Joëlle Miffre
This paper constructs factor-mimicking portfolios that capture the hedging-pressure-based risk premium of commodity futures. It considers single sorts based on the open interests of either hedgers or speculators, as well as double sorts based on both positions. It finds strong evidence for a risk premium arising from the combination of the two positions. Further tests show that the hedging-pressure-based risk premium rises with the lagged volatility of commodity markets and that the cross-sectional price of commodity risk is positive. Our risk premium is also found to explain part of the performance of active portfolios based on momentum and/or term structure.
Conditional Return Correlations between Commodity Futures and Traditional Assets
James Chong, Joëlle Miffre
The article studies the temporal variations in the conditional return correlations between commodity futures and traditional asset classes (global stock and fixed-income indices). It reveals that the conditional correlations between commodity futures and S&P500 returns fell over time, a sign that commodity futures have become better tools for strategic asset allocation. The correlations with equity returns also fell in periods of above average volatility in equity markets. We see this as welcome news to long institutional investors as they need the benefits of diversification most in periods of high volatility in equity markets. Similarly, falls in return correlations between commodity futures and Treasury-bills go hand in hand with rises in short-term interest volatility, suggesting that adding commodity futures to Treasury-bill portfolios reduces risk further in volatile interest rate environments. A revisited version of this working paper was published in the Journal of Alternative Investments, Winter 2010.
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