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Optimal commodity asset allocation with a coherent market risk modeling


  • Al Janabi, Mazin A.M.


This paper fills a fundamental gap in commodity price risk management and optimal portfolio selection literatures by contributing a thorough reflection on trading risk modeling with a dynamic asset allocation process and under the supposition of illiquid and adverse market settings. This paper analyzes, from a portfolio managers' perspective, the performance of liquidity adjusted risk modeling in obtaining efficient and coherent investable commodity portfolios under normal and adverse market conditions. As such, the author argues that liquidity risk associated with the uncertainty of liquidating multiple commodity assets over given holding periods is a key factor in formalizing and measuring overall trading risk and is thus an important component to model, particularly in the wake of the repercussions of the recent 2008 financial crisis. To this end, this article proposes a practical technique for the quantification of liquidity trading risk for large portfolios that consist of multiple commodity assets and whereby the holding periods are adjusted according to the specific needs of each trading portfolio. Specifically, the paper proposes a robust technique to commodity optimal portfolio selection, in a liquidity-adjusted value-at-risk (L-VaR) framework, and particularly from the perspective of large portfolios that have both long and short positions or portfolios that consist of merely pure long trading positions. Moreover, in this paper, the author develops a portfolio selection model and an optimization-algorithm which allocates commodity assets by minimizing the L-VaR subject to applying credible operational and financial constraints based on fundamental asset management considerations. The empirical optimization results indicate that this alternate L-VaR technique can be regarded as a robust portfolio management tool and can have many uses and applications in real-world asset management practices and predominantly for fund managers with large commodity portfolios.

Suggested Citation

  • Al Janabi, Mazin A.M., 2012. "Optimal commodity asset allocation with a coherent market risk modeling," Review of Financial Economics, Elsevier, vol. 21(3), pages 131-140.
  • Handle: RePEc:eee:revfin:v:21:y:2012:i:3:p:131-140
    DOI: 10.1016/j.rfe.2012.06.007

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    References listed on IDEAS

    1. Satyanarayan, Sudhakar & Varangis, Panos & DEC, 1994. "An efficient frontier for international portfolios with commodity assets," Policy Research Working Paper Series 1266, The World Bank.
    2. Ben White & P. J. Dawson, 2005. "Measuring Price Risk on UK Arable Farms," Journal of Agricultural Economics, Wiley Blackwell, vol. 56(2), pages 239-252.
    3. Weron, Rafal, 2000. "Energy price risk management," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 285(1), pages 127-134.
    4. Giot, Pierre & Laurent, Sebastien, 2003. "Market risk in commodity markets: a VaR approach," Energy Economics, Elsevier, vol. 25(5), pages 435-457, September.
    5. Jorion, Philippe, 1991. "Bayesian and CAPM estimators of the means: Implications for portfolio selection," Journal of Banking & Finance, Elsevier, vol. 15(3), pages 717-727, June.
    6. Best, Michael J & Grauer, Robert R, 1991. "On the Sensitivity of Mean-Variance-Efficient Portfolios to Changes in Asset Means: Some Analytical and Computational Results," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 315-342.
    7. Timotheos Angelidis & Alexandros Benos, 2006. "Liquidity adjusted value-at-risk based on the components of the bid-ask spread," Applied Financial Economics, Taylor & Francis Journals, vol. 16(11), pages 835-851.
    8. William W. Wilson & William E. Nganje & Cullen R. Hawes, 2007. "Value-at-Risk in Bakery Procurement," Review of Agricultural Economics, Agricultural and Applied Economics Association, vol. 29(3), pages 581-595.
    9. Mark R. Manfredo & Raymond M. Leuthold, 2001. "Market risk and the cattle feeding margin: An application of Value-at-Risk," Agribusiness, John Wiley & Sons, Ltd., vol. 17(3), pages 333-353.
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    Cited by:

    1. Wilford, D. Sykes, 2012. "True Markowitz or assumptions we break and why it matters," Review of Financial Economics, Elsevier, vol. 21(3), pages 93-101.

    More about this item


    Commodity; Financial crisis; Financial engineering; Liquidity risk; Portfolio management;

    JEL classification:

    • C10 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - General
    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation


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