Commodity-linked Arbitrage Strategies and Portfolio Management

The aim of an investor or a speculator who operates in the markets is to select and apply successful investment strategies that enable to make profits more or less in line with his risk profile. An individual could make trading of assets, for example when he needs physical assets for industrial processes or for hedging or simply for speculation, or he could select and manage a portfolio allocation if he needs hedging or only for more broadly investing. Recently there has been a growing interest in commodity markets, on one hand because they occur in arbitrage opportunities that can be exploited for profit by using appropriate trading rules, on the other hand because, given the intrinsic characteristics of their returns and risk premiums, commodities result being an asset class whose investment provides diversification of risk of a traditional portfolio. The chapter is divided into two parts. In the first part, after describing the inefficiencies of commodity markets that give rise to arbitrage opportunities, we review several trading techniques, from the most basic and classic strategies found in Technical Analysis, to the modern Statistical Arbitrage strategies. In the second part, commodities are classified as asset class and we discuss the characteristics of their returns and risk premiums. Finally, through a portfolio risk-return analysis we show how commodities represent a good diversifier of portfolio risk and describe the possible risk measures that can be used in portfolio optimization with commodities.