Dissertation: Commodity Investing Are There Potential

Pages: 20 (7238 words)  ·  Bibliography Sources: 25  ·  Level: Master's  ·  Topic: Economics  ·  Buy This Paper


[. . .] Are commodity investments an appropriate tool for Norwegian Investors who wish to add different types of assets to their portfolio?

1.5 Purpose

The purpose of the study is to explore the relationship between the commodity market and the Norwegian stock market. It will also explore other diversification instruments in comparison to commodities. The results of this study will provide Norwegian investors with solid information that they can utilize in their investment decisions.

1.6 Delimitations

This research paper has limited its research to correlations between the Dow Jones commodity index and its various commodities sectors with the Norwegian stock market. It will utilize the years between 2000 and 2010. This period of time should provide sufficient data points for comparison.

In our assumptions it was noted that it would be assumed that Norwegian Investors would invest in Norwegian commodities. The home bias phenomenon is recognized any time it is assumed that an inve stor will invest in their home stocks rather than international markets.

1.7 Definition of Concepts

The following operational definitions will be utilized in the conduct of this study.

Asset Allocation refers to a collection of investments held by an investor utilizing various types of instruments.

Correlation is defined as synchronous movement between various types of assets

Diversification is defined as the practice of reducing risk by investing in a variety of different investment instruments.

Norwegian investor for the purpose of this research is an investor that invests in the Norwegian securities market. The exact nature of the investor's portfolio cannot be determined within the scope of this research study. The assumption that Norwegian Investors will hold a majority of their stocks in the Norwegian market is a generalization, but one that is necessary for practical reasons in the course of the study.

OBX stock index (Norwegian stock index) is an index that follows the top companies in the Norwegian stock index. It covers companies from a sampling of different sectors and is used as a benchmark for the overall movement of the stock market. It only takes into account stock price, not reinvested dividends.

Risk averse is a term that refers to an investor that prefers to avoid high risk investments at the expense of higher returns. This type of investor is the opposite of the risk-tolerant investor who will often take risks if the potential for return is significantly high.

2. Literature Review

Volumes have been written about commodity indices and their relationship to the stock market. Diversification and risk management are global issues that grow in importance as the future of the global economy becomes more uncertain. With a topic that has such a wealth of information one must refine their search and discuss only those studies are directly influence the current research. This literature review will be divided into two major headings. The first explores the characteristics of commodity investing and its performance under various market conditions. The second major heading will provide an overview of other commodities that investors could use to diversify their portfolios. It will explore the strengths and weaknesses of these investment tools.

Before we begin a formal investigation of literature related to the research questions, let us first begin with an introduction to the Norwegian stock exchange and some common facts that are known about it. The Norwegian stock exchange, Also known as Oslo BOrs (OSE:Oslo) is the main Norwegian market. It offers a wide selection of domestic stocks as well as international companies, particularly within the petroleum industry, shipping, and other related areas. This high number of companies in the petroleum industry makes the OBX Index highly price sensitive to significant changes in the petroleum industry.

By comparison to the Swedish stock exchange, the Oslo stock exchange is much smaller. However, the Scandinavian stock exchange also has an affect on the Norwegian exchange, as the Norwegian exchange purchased the 10% strategic stake in the pan -- Scandinavian exchange group. The small size of the Norwegian exchange, and its primary index make it more volatile than larger exchanges. The OBX consists of the 25 most traded securities on the exchange. The energy sector contains 74 stocks, a majority of which are connected to the oil and gas industry (www.oslobors.no). The Oslo stock exchange has 214 total domestic stocks listed. It has 49 foreign stocks listed for a total of 263 individual stocks. The energy sector comprises 28% of the Oslo exchange (TopForeignStocks.com). As one can see, the energy sector comprises a major portion of the exchange. Circumstances that affect the oil and gas industry have a major impact on the Oslo stock exchange and its related indices. Now that we have an introduction to the Oslo stock exchange and the key factors that affect it, let us now delve into a detailed discussion of literature related to the research topic.

2.1 Commodities and Risk Reduction

The first topic to be discussed will explore literature regarding commodity futures and the various factors that influence its suitability as a risk management and diversification strategy. Studies on this topic are numerous, but tend to be highly opinionated with very little substantial positivist research to support it. For the purposes of this study, only studies that use positivist quantitative methods will be considered.

Li, Zhang, and Du (2011) altered one of the most comprehensive studies in the area of short-term and long-term fluctuations in the commodity -- equity correlation. Their research encompassed global markets in different economic circumstances. They explored both short- term volatility and long-term trends. Their key finding was that in general, as volatility increases in the equity markets, it causes a short-term upward spike in commodity futures. If one takes only a short-term look at commodities, they would appear to be more volatile than the equity markets. However, when one smooths out the trend over a longer period of time, the commodity markets are much less volatile than equity markets. Let us take a closer look at their study.

Li, Zhang, and Du used a sample population of 45 equity markets from around the world. This makes it one of the largest comparative studies in existence concerning correlation of commodity futures and other indices. This study takes a different approach than the current research study in terms of sample population size and the ability to generalize the results. Li, Zhang, and Du found that 32 of the equity markets demonstrated an upward trend in the long run and that these markets correlated with commodity futures in the decade preceding this study. The study used the time period for its data set that the current study will use. Of the 45 equity markets studied all of them had sharp spikes when the economic turmoil occurred. In many cases the short-term spikes rose above the level of their long-term trends.

The method used in the study is similar to Pearson product moment correlation. This meant that allowed the authors to examine a variety of time periods for comparison. Correlation coefficients were used to determine whether the data were positively, negatively, or not related at all. They could calculate the short-term and long-term periods. The overall conclusion of the study was that commodity futures have potential for risk management and diversification strategies in the long run. The volatility of the spikes in the short run makes them unsuitable for this type of investing. The conclusions drawn were supported by the data collected and analyzed through the course of the study.

When one examines the conclusions and methodology utilized by Li, Zhang, and Du, one will find many similarities between this larger study and others that only examined a single country. The study examined 43 indices on an individual basis. The indices were not as analyzed in aggregate, but were analyzed to obtain a view of their trends. These trends were compared in the final analysis. The conclusions of the study are valid based on the diversity of markets and economic conditions that the data encompassed. The research was written in such a way that one could extract the results from one country and take a closer look at the specific conditions that influenced it. When he results of the study are applied over different market and economic conditions, it increased the validity and reliability of the study.

Chueng and Miu (2010) performed another important exploration of the benefits of commodity futures and diversification strategy. Rather than utilizing correlation studies their study involved the Time-series plot of smooth probabilities of two hypothetical states. State one represented low return and low volatility of the commodity index over time. This work is highly cited in other works about commodity futures and diversification. However, this study only deals with probabilities not actual market occurrences. Unlike the study by Li, Zhang, and Du, this study only results in the probability of two different hypothetical situations. In reality there are many other possibilities that could exist given the circumstances being explored by these authors.

Literature supports the diversification benefits of commodity futures. Chueng and Miu… [END OF PREVIEW]

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