On the Correlation between Commodity and Equity Returns: Implications for Portfolio Allocation

34 Pages Posted: 27 Feb 2014

See all articles by Marco J. Lombardi

Marco J. Lombardi

Bank for International Settlements (BIS) - Monetary and Economic Department

Francesco Ravazzolo

Free University of Bolzano

Date Written: July 2013

Abstract

In the recent years several commentators hinted at an increase of the correlation between equity and commodity prices, and blamed investment in commodity-related products for this. First, this paper investigates such claims by looking at various measures of correlation. Next, we assess what are the implications of higher correlations between oil and equity prices for asset allocation. We develop a time-varying Bayesian Dynamic Conditional Correlation model for volatilities and correlations and find that joint modelling commodity and equity prices produces more accurate point and density forecasts, which lead to substantial benefits in portfolio allocation. This, however, comes at the price of higher portfolio volatility. Therefore, the popular view that commodities are to be included in one's portfolio as a hedging device is not grounded.

Keywords: Commodity prices, equity prices, density forecasting, correlation, Bayesian DCC

JEL Classification: C11, C15, C53, E17, G17

Suggested Citation

Lombardi, Marco Jacopo and Ravazzolo, Francesco, On the Correlation between Commodity and Equity Returns: Implications for Portfolio Allocation (July 2013). BIS Working Paper No. 420. Available at SSRN: https://ssrn.com/abstract=2384446

Marco Jacopo Lombardi (Contact Author)

Bank for International Settlements (BIS) - Monetary and Economic Department ( email )

Centralbahnplatz 2
CH-4002 Basel
Switzerland
+41612809492 (Phone)

Francesco Ravazzolo

Free University of Bolzano ( email )

Bolzano
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
220
Abstract Views
885
rank
138,806
PlumX Metrics