Commodity futures as an asset class an empirical evidence from Indian market

Abstract

The risk-reduction benefit of diversification is an important aspect of financial management. However, the traditional choice of asset allocation for a risk averse investor in the portfolio includes stocks, bonds and treasury bills (T-bills). The research examines the role of commodity futures as an asset class in a traditional portfolio for a rational Indian investor, whose objective is to build a portfolio that maximizes the excess return per unit of total risk. Commodity futures are investigated as an alternative asset class since the factors that drive the commodity prices (e.g., weather and geopolitical conditions, supply constraints in the physical production, and event risk) are distinct from those that determine the value of stocks and bonds. The decision to include an alternative asset to a traditional portfolio for diversification depends not only on the temporal risk-return characteristics but also on how it correlates with the other assets in the portfolio over time. Therefore, to study and analyse the asset like properties of commodity futures the research is carried out in two phases. Firstly, it examines the long term statistical relationship of commodity future prices with other asset classes and also investigates the short term dynamics of prices by testing for the existence and direction of inter-temporal Granger-causality between the indices. The second phase tests the diversifying properties of commodity futures by examining the role of commodity futures as an asset class in a traditional portfolio consisting of equity and bond using mean variance optimization technique at various risk aversion levels of the investor. The analysis is based on the daily prices for the indices, Equity (SandP CNX Nifty), Bond (NSE G-Sec), Treasury Bill (NSE TB Index) and Commodity futures (MCX COMDEX) for the period June, 2005 to December, 2011. The findings show that commodity futures have a significant low correlation with equity and statistically significant negative relationship with bond.