Applying Spatial Pricing Equilibrium Model In Asset Allocation With Commodity

This paper studies the role of commodity in the context of asset allocation.During the past 15 years,portfolios without commodity indexes performed better than portfolios with commodity indexes.This was due to the weakening return rate and hedging attributes of commodity indexes.This paper uses rebalancing strategy with signal indicator to optimize portfolios including commodities.In theory,rebalancing strategy avoids the risk of a single asset overwhelming other assets in the same portfolio by rebalancing the portfolio to a predestined weight.Rebalancing strategy with signal indicators provides investor market timing without compromising risk controlling ability.Signal indicator is composed of both commodities’ supply and demand,in which demand data cannot be observed directly in the market.Therefore,this paper uses spatial pricing equilibrium model to calculate the equilibrium demand of iron ore.Every time the signal indicator deviates from its mean by a standard deviation,the portfolio is rebalanced.The empirical results show that comprehensive performance of rebalancing strategy with signal indicators is better than normal rebalancing strategy and simple buy-and-hold strategy.Specifically,it has the highest Sharp ratio and the lowest maximum drawdown.By using Treynor-Mazuy model and Henriksson-Merton model,this paper shows the excess return of this strategy comes from market timing.This paper innovatively utilizes spatial pricing equilibrium model to create signal indicator.The empirical performance is notable.Besides demand prediction,spatial pricing equilibrium model may be used to predict commodities’ rate of return as the study goes further.