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.

Macro Asset Allocation with Social Impact Investments

“…Some literature reviews, such as Skiadopoulos [15], concern this topic. Most papers empirically confirm this diversification benefit (see, for instance, [16][17][18]). However, there is no unanimous consensus on this result, with different conclusions drawn, for instance, by Cao et al [19], Daskalaki and Skiadopoulos [20], Bessler and Wolff [21], and Lombardi and Ravazzolo [22].…”

Properties of Long/Short Commodity Indices in Stock and Bond Portfolios

“…Both Yan and Garcia [2014] and Kremer [2015] find evidence of diversification benefits of third-generation commodity indices in an out-ofsample mean-variance framework, thereby indicating an increase in returns and a reduction in risk. Daskalaki et al [2015] support this using a stochastic-dominance approach for portfolio optimization. The main drawback of the latter and Yan and Garcia [2014] is that they employ only momentum-based long/short commodity indices to test the diversification properties.…”

“…Several previous studies only use two market cap-weighted indices, representing stocks and bonds as their investment universe (see e.g., Yan and Garcia [2014]; Kremer [2015]; Daskalaki et al [2015]). When using a two-index approach, the results are not based on a well-diversified portfolio.…”

Exploring the Dynamic Links between GCC Sukuk and Commodity Market Volatility

“…They found that commodities are not effective hedges for equity market investors during normal or crisis periods. However, Daskalaki et al (2017) found that commodities provide diversification benefits for second and third generation indices. This result holds for both in-sample and out-of-sample and for different equity strategies.…”