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FRM Part II · FRM Exam Part II · Empirical Properties of Correlation: How Do Correlations Behave in the Real World?

A portfolio manager holds a diversified basket of commodity futures and notes that commodity correlations differ from equity correlations. Which statement best describes empirical evidence on commodity correlations?

Commodity correlations are typically higher within a sector, such as energy, than across sectors, and historically have been low relative to equities. They are not uniformly near +1 or strongly negative, so a diversified commodity basket offered diversification, although crises can raise correlations.

  1. ACommodity correlations are usually higher within the same sector, such as energy, than across sectors, and are often near zero versus equities historicallyCorrect
  2. BAll commodities show correlations near +1 with each other at all times
  3. CCommodity correlations with equities have always been strongly negative
  4. DCommodity correlations are identical to bond correlations because both are priced from interest rates

Explanation

Commodities within a sector (e.g., crude and heating oil) share fundamentals and correlate highly, while cross-sector and commodity-equity correlations have historically been low. The other options overstate uniform or strongly negative relationships. Correlations can rise in crises, but they are not fixed at +1.

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