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Negative correlation between stock and futures returns: an unexploited dedging opportunity?

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  • Parantap Basu
  • William T. Gavin

Abstract

For over a decade, academic and industry economists argued that the negative correlation between returns on stocks and commodity futures was evidence that institutional investors should add commodity futures index funds as an asset class in their portfolio management strategies. Does this negative correlation give rise to the possibility of unexploited profit opportunity in the financial markets? Using a rational asset-pricing model, we argue that such a negative correlation could arise as a no-arbitrage equilibrium phenomenon and reflects traders’ perceptions about the fundamental processes driving the economy and commodity prices.

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Bibliographic Info

Paper provided by Federal Reserve Bank of St. Louis in its series Working Papers with number 2011-005.

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Date of creation: 2011
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Handle: RePEc:fip:fedlwp:2011-005

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Keywords: Stocks - Rate of return ; Commodity futures;

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  1. Gary Gorton & K. Geert Rouwenhorst, 2004. "Facts and Fantasies about Commodity Futures," NBER Working Papers 10595, National Bureau of Economic Research, Inc.
  2. Ke Tang & Wei Xiong, 2010. "Index Investment and Financialization of Commodities," NBER Working Papers 16385, National Bureau of Economic Research, Inc.
  3. Parantap Basu & William T. Gavin, 2011. "What explains the growth in commodity derivatives?," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 37-48.
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Cited by:
  1. Chanont Banternghansa & Michael W. McCracken, 2011. "Real-time forecast averaging with ALFRED," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 49-66.
  2. Parantap Basu & William T. Gavin, 2011. "What explains the growth in commodity derivatives?," Review, Federal Reserve Bank of St. Louis, issue Jan, pages 37-48.

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