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The Rank Effect for Commodities

Last Updated on 10 February, 2024 by Rejaul Karim

The study, “The Rank Effect for Commodities,” delves into a comprehensive analysis of a substantial and noteworthy anomaly in commodities over two centuries—the low-minus-high rank effect.

Authored by Ricardo T. Fernholz and Christoffer Koch, the research highlights the significance of this anomaly, presenting compelling evidence of its persistence and potency. Utilizing nonparametric econometric methods, the study demonstrates that the rank effect is intricately tied to the stationary relative asset price distribution.

Notably, the results reveal a stark 23% higher annual return for portfolios comprising lower-ranked, lower-priced commodities compared to their higher-ranked counterparts, with a Sharpe ratio nearly twice as high as the U.S. stock market.

This anomaly stands out for its structural underpinnings, offering profound implications for long-run asset pricing dynamics.

Abstract Of Paper

We uncover a large and significant low-minus-high rank effect for commodities across two centuries. There is nothing anomalous about this anomaly, nor is it clear how it can be arbitraged away. Using nonparametric econometric methods, we demonstrate that such a rank effect is a necessary consequence of a stationary relative asset price distribution. We confirm this prediction using daily commodity futures prices and show that a portfolio consisting of lower-ranked, lower-priced commodities yields 23% higher annual returns than a portfolio consisting of higher-ranked, higher-priced commodities. These excess returns have a Sharpe ratio nearly twice as high as the U.S. stock market yet are uncorrelated with market risk. In contrast to the extensive literature on asset pricing factors and anomalies, our results are structural and rely on minimal and realistic assumptions for the long-run properties of relative asset prices.

Original paper – Download PDF

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Author

Ricardo T. Fernholz
Claremont McKenna College – Robert Day School of Economics and Finance

Christoffer Koch
Federal Reserve Bank of Dallas

Conclusion

In conclusion, the research on the rank effect for commodities sheds light on a compelling and substantial anomaly that has persisted over two centuries, bringing to the forefront an enigmatic low-minus-high rank effect.

The study’s utilization of nonparametric econometric methods has not only validated the anomaly but also linked it to the necessary consequence of a stationary relative asset price distribution. Furthermore, the findings exemplify a remarkable 23% higher annual return from portfolios comprising lower-ranked, lower-priced commodities, in contrast to their higher-ranked counterparts.

These excess returns exhibit a notable Sharpe ratio that surpasses that of the U.S. stock market, with no discernible correlation with market risk. Contrary to conventional literature on asset pricing, these results underscore the structural intricacies of this anomaly and its minimal reliance on realistic assumptions, offering valuable insights into the long-term dynamics of relative asset prices.

Related Reading:

What Does Futures Market Interest Tell Us about the Macroeconomy and Asset Prices?

The Seasonality of Gold – The Autumn Effect

FAQ

Q1: What is the main focus of the study on “The Rank Effect for Commodities” by Ricardo T. Fernholz and Christoffer Koch?

A1: The main focus of the study is to analyze the low-minus-high rank effect in commodities, a substantial anomaly that has persisted over two centuries. The research aims to uncover the significance of this anomaly and its structural underpinnings, presenting compelling evidence of its persistence and potency in the context of relative asset prices in commodities.

Q2: How does the study establish the connection between the rank effect and the stationary relative asset price distribution in commodities?

A2: The study utilizes nonparametric econometric methods to demonstrate that the rank effect is a necessary consequence of a stationary relative asset price distribution. By employing rigorous statistical techniques, the research establishes a link between the structural properties of the relative asset price distribution and the observed low-minus-high rank effect in commodities.

Q3: What are the key findings regarding the performance of portfolios comprising lower-ranked, lower-priced commodities compared to higher-ranked ones?

A3: The study reveals a stark 23% higher annual return for portfolios consisting of lower-ranked, lower-priced commodities compared to portfolios comprising higher-ranked, higher-priced commodities. Additionally, these excess returns exhibit a Sharpe ratio nearly twice as high as the U.S. stock market. The findings highlight the potency and persistence of the rank effect in commodities, with profound implications for understanding long-run asset pricing dynamics.

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