Volatility and Correlation Timing : The Role of Commodities

This paper examines the role of commodities in asset allocation from the perspective of dynamic portfolio management. To this end, we model conditional variances and correlations of stock, bond and commodity futures to study how conditional second moments affect the optimal portfolio choice of a risk-averse investor in a mean-variance setting. Our findings validate the alleged diversification benefits of commodities as their addition in the opportunity set enhances portfolio risk-return characteristics. Moreover, there is substantial economic value in both volatility and correlation timing strategies. Our results are robust across various sub-periods, different specifications for correlation dynamics, alternative rebalancing strategies and reasonable transaction costs while they are confirmed under both in- and out-of-sample settings