Financialization of Commodity Futures - Impact to Index and Momentum Investing: Empirical Evidence 1991-2015

Abstract

Objectives of the study

In this thesis, I study the impact of financialization of commodity futures to their index and momentum investing strategies. I test if the return characteristics of long-only and momentum investing strategies correlate differently with equities, and if there exists time variation in these correlations. I also analyze the prediction power of equities volatility to the increase of equities and commodities cross-asset correlation.

Data and methodology

My sample covers the daily returns of the S&P Goldman Sachs Commodity Index (GSCI), its sub-sectors and 24 individual commodities from Jan 1, 1991 to Dec 31, 2015. The sample is collected from Datastream. Generalized Autoregressive Conditional Heteroskedasticity (GARCH) process is used in estimating the conditional volatilities of commodities, and dynamic conditional correlation model is used in estimating time varying conditional correlations between S&P500 index and commodities. The impact of stock market volatility to cross-asset correlation between equities and commodities is analyzed with OLS regression. Sensitivity analysis is used to recognize the high market stress during post-Lehman collapse period as an additional explaining variable.

Findings of the study

The findings of this study indicate that commodity futures returns have considerable time variation, where time-series and cross-sectional momentum strategies produce statistically significant returns during the whole sample period. Moreover, momentum strategies have less downside risk than GSCI, its sub-sectors and individual commodities. Momentum strategies do not take consistently positions in commodities with steep future curves and high roll returns, which indicates to the generic decrease of the roll-return component due to the financialization of commodities. The correlation between industrial metals, energy commodities and equities increased significantly from Sep 2008, and was exceptionally high till the end of 2012. During this period, their cross-asset correlation with equities became sensitive to uncertainty in the stock market implied by its volatility. These findings support the view that the financialization of energy and industrial metal futures has made them a satellite market of equities.