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Oil and portfolio risk diversification

  • Cifarelli, Giulio
  • Paladino, Giovanna

The growing presence of financial operators in the oil market has brought about the diffusion of techniques - such as feedback trading - which lead to departures of prices from their fundamental values and increase their variability. Oil price changes are here associated with changes in stocks, bonds and effective USD exchange rate. The feedback trading mechanism is combined with an ICAPM scheme. This original model is estimated in a four asset CCC GARCH non linear framework, where the risk premium and the feedback trading components of the conditional means are multiplicative functions of the system’s conditional variances and covariances. The empirical analysis, which encompasses the 2008-2009 financial crisis, identifies a structural change in the year 2000. From then on oil returns tend to become more reactive to the remaining assets of the model and feedback trading more pervasive. A comparison is drawn between three and four asset minimum variance portfolios in the two sub-periods, 1992-1999 and 2000-2009. Indeed, the trade-off between risk and returns – measured here by the average return per unit of risk index – indicates that in the last decade oil diversifies away the empirical risk of our portfolio.

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Paper provided by University Library of Munich, Germany in its series MPRA Paper with number 28293.

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Date of creation: Dec 2009
Date of revision: Nov 2010
Handle: RePEc:pra:mprapa:28293
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  2. Koutmos, Gregory, 1997. "Feedback trading and the autocorrelation pattern of stock returns: further empirical evidence," Journal of International Money and Finance, Elsevier, vol. 16(4), pages 625-636, August.
  3. David M. Cutler & James M. Poterba & Lawrence H. Summers, 1990. "Speculative Dynamics and the Role of Feedback Traders," NBER Working Papers 3243, National Bureau of Economic Research, Inc.
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  11. Sadorsky, Perry, 1999. "Oil price shocks and stock market activity," Energy Economics, Elsevier, vol. 21(5), pages 449-469, October.
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  15. Shaun K. Roache, 2008. "Commodities and the Market Price of Risk," IMF Working Papers 08/221, International Monetary Fund.
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