Handbook of Multi-Commodity Markets and Products: Structuring, Trading and Risk Management

CHAPTER 20 Commodity-Linked Arbitrage Strategies and Portfolio Management

Viviana Fanelli

The aim of an investor or a speculator who operates in the markets is to select and apply successful investment strategies that enable profit to be made, more or less in line with his risk profile. An individual could trade in specific assets, for example when physical assets for industrial processes are needed or for hedging or simply for speculation, or he could select and manage a portfolio of assets again for hedging or simply for broad-based, diversified investing. Recently there has been growing interest in commodity markets; on the one hand because they offer arbitrage opportunities that can be exploited using appropriate trading rules, while on the other hand because, given their intrinsic risk–return characteristics, commodities provide diversification of risk for traditional portfolios.

This chapter is divided into two parts. In the first part, a detailed discussion of commodity-linked arbitrage strategy is carried out. First, the efficient market hypothesis theory is illustrated, as formulated by Fama (1970) and according to later reinterpretations. Some of the assumptions underlying the efficient market hypothesis do not hold in commodity markets that reveal temporary inefficiencies. These inefficiencies give rise to arbitrage opportunities that can be identified through statistical methods, some of which are presented in this chapter. Several trading techniques are reviewed, ...