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Portfolio optimization of financial commodities with energy futures

Author

Listed:
  • Lu Wang

    (Shandong University of Science and Technology)

  • Ferhana Ahmad

    (Lahore University of Management Sciences)

  • Gong-li Luo

    (Shandong University of Science and Technology)

  • Muhammad Umar

    (University of Central Punjab)

  • Dervis Kirikkaleli

    (European University of Lefke)

Abstract

The recent growth in economic and financial markets has brought the focus on energy derivatives as an alternative investment class for investors, financial analysts, and portfolio managers. The financial modeling and risk management of portfolios using the energy derivatives instrument is a requirement and challenge for researchers in the field. The energy and other commodity futures force the expert investors to investigate the broader investment spectrum and consequently diversify their portfolios using the futures instruments. Going beyond the conventional portfolios and developing out-of-the-box strategies that comply with the changing financial and economic advancements are the keys to long-term sustainability in the financial world. This study investigates the impact of diversification with five energy futures from January 2011 to July 2020 on three traditional commodity futures portfolios. The results show that diversification increased the returns while simultaneously reducing the portfolio volatility in all portfolios. The diversified portfolios provided higher returns than the traditional portfolios for the same level of risk. This study also revealed that the results might improve when a short position in the futures contracts is allowed. Moreover, we conclude that adding multiple energy futures in a portfolio provides enhanced diversification results, whereas the WTI crude oil futures fail to diversify any portfolio considered in the study.

Suggested Citation

  • Lu Wang & Ferhana Ahmad & Gong-li Luo & Muhammad Umar & Dervis Kirikkaleli, 2022. "Portfolio optimization of financial commodities with energy futures," Annals of Operations Research, Springer, vol. 313(1), pages 401-439, June.
    • Handle: RePEc:spr:annopr:v:313:y:2022:i:1:d:10.1007_s10479-021-04283-x
    DOI: 10.1007/s10479-021-04283-x
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    More about this item

    Keywords

    Energy futures; Portfolio diversification; Commodity futures; Risk management; Mean–variance analysis; Efficient frontier;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G1 - Financial Economics - - General Financial Markets
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • F65 - International Economics - - Economic Impacts of Globalization - - - Finance

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