Predictability and Diversification Benefits of Investing in Commodity and Currency Futures

Abstract

We re-examine diversification benefits of investing in commodities and currencies by considering a risk-averse investor with mean-variance preferences who exploits the possibility of predictable time variation in asset return means, variances, and covariances. We implement unconditional and conditional efficient portfolio strategies designed to exploit predictability, together with more traditional ones hitherto explored in this context (including the equally weighted, fixed weight, volatility timing, and reward-to-risk timing strategies). We find that, for all portfolio strategies, commodity and currency futures do not improve the risk-return trade-off of an investor with an existing portfolio of traditional assets (stocks and bonds), and an investment horizon of one-month. Our findings, which reverse the conclusions of previous studies that focus on static portfolio strategies, are robust across several performance metrics.

Keywords: Portfolio choice, Asset classes, Spanning tests, Predictability, Performance evaluation

JEL Classification: C53, G10, G11, G12