Commodity hedging benefits: analyses among different financial assets

Abstract

PurposeThis study aims to investigate the benefits of commodity hedging in the global stock index, bond and foreign currency (FX) portfolios.Design/methodology/approachThe authors compare various hedging strategies and factor transaction costs. The authors analyze equally weighted, dynamic hedging ratio, risk parity and reward to risk timing strategies. Volatilities are estimated using historical, GARCH(1,1), and APARCH(1,1) methods. In addition, the authors evaluate the portfolio's hedging performance (HP) based on four different dimensions: volatility (annualized standard deviation), Sharpe ratio (SR), HP, and high-low ratio (HL).FindingsThe authors observe different benefits of the commodity hedging strategy among financial assets (stocks, bonds or FX).The authors find that commodity hedging in the stock markets is the best option, if the authors optimize the hedging ratio using dynamic hedging from historical data. The authors also document that for stock portfolio managers, adding commodities will generate a more conservative strategy, whereas for bond and/or FX portfolio managers, adding commodities will generate a more aggressive strategy.Originality/valueThis study contributes to the literature by investigating commodity hedging in the global stock index, bond and FX portfolios. First, the authors provide details on the diversification benefits in the commodities. Second, the authors document the hedging strategy that is the best as a part of the diversification strategy by adding commodities. Third, the authors provide a practical analysis by reporting the financial assets portfolio that is appropriate for commodity hedging following the portfolio managers' objectives (e.g. reducing risks or improving the risk-reward ratio).