Optimal commodity asset allocation with a coherent market risk modeling

Mazin A.M. Al Janabi

    Research output: Contribution to journalArticlepeer-review

    18 Citations (Scopus)

    Abstract

    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.

    Original languageEnglish
    Pages (from-to)131-140
    Number of pages10
    JournalReview of Financial Economics
    Volume21
    Issue number3
    DOIs
    Publication statusPublished - Sep 2012

    Keywords

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

    ASJC Scopus subject areas

    • Finance
    • Economics and Econometrics

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