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WTI crude oil Futures in portfolio diversification: The time-to-maturity effect

  • Geman, Hélyette
  • Kharoubi, Cécile
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    The aim of the paper is to analyze the diversification effect brought by crude oil Futures contracts, the most liquid commodity Futures, into a portfolio of stocks. The studies that have documented the very low- and essentially negative-correlations between commodities and equities typically rely on normally distributed returns, which is not the case for crude oil Futures and stocks indexes. Moreover, the particular time-to-maturity chosen for the Future contract used as an investment vehicle is an important matter that needs to be addressed, in presence of forward curves switching between backwardation and contango shapes. Our goal in this paper is twofold: (a) we introduce copula functions to have a better representation of the dependence structure of oil Futures with equity indexes; (b) using this copula representation, we are able to analyze in a precise manner the "maturity effect" in the choice of crude oil Future contract with respect to its diversification benefits. Our finding is that, in the case of distant maturities Futures, e.g., 18 months, the negative correlation effect is more pronounced whether stock prices increase or decrease. This property has the merit to avoid the hurdles of a frequent roll over while being quite desirable in the current trendless equity markets. Empirical evidence is exhibited on a database comprising the NYMEX WTI crude oil Futures and S&P 500 index over a 15 year-time period.

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    File URL: http://www.sciencedirect.com/science/article/B6VCY-4SBHX2F-3/2/3517415e5b0180ebe2dc15fe3187ef42
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    Article provided by Elsevier in its journal Journal of Banking & Finance.

    Volume (Year): 32 (2008)
    Issue (Month): 12 (December)
    Pages: 2553-2559

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    Handle: RePEc:eee:jbfina:v:32:y:2008:i:12:p:2553-2559
    Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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    1. Levy, Haim & Sarnat, Marshall, 1970. "International Diversification of Investment Portfolios," American Economic Review, American Economic Association, vol. 60(4), pages 668-75, September.
    2. Geman, Hélyette, 2005. "Commodities and commodity derivatives : modeling and pricing for agriculturals, metals and energy," Economics Papers from University Paris Dauphine 123456789/607, Paris Dauphine University.
    3. Stevenson, Richard A & Bear, Robert M, 1970. "Commodity Futures: Trends or Random Walks?," Journal of Finance, American Finance Association, vol. 25(1), pages 65-81, March.
    4. Geman, Hélyette, 2005. "Energy Commodity Prices : Is Mean-reversion Dead ?," Economics Papers from University Paris Dauphine 123456789/1442, Paris Dauphine University.
    5. Thierry Ane & Cecile Kharoubi, 2003. "Dependence Structure and Risk Measure," The Journal of Business, University of Chicago Press, vol. 76(3), pages 411-438, July.
    6. François Longin, 2001. "Extreme Correlation of International Equity Markets," Journal of Finance, American Finance Association, vol. 56(2), pages 649-676, 04.
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