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 portfolio of commodity futures and wants to understand typical correlation patterns. Which statement is most accurate regarding correlations among commodity futures returns?
Commodity correlations are typically low across different sectors but high within a sector, for example crude oil and its refined products. Shared supply and demand drivers explain the within-sector linkage, while unrelated sectors such as energy and agriculture respond to different fundamentals.
- ACorrelations across unrelated commodity groups, such as energy and agriculture, are usually very high and stable
- BCorrelations are typically low between different commodity sectors but higher within a sector, such as among crude oil and refined productsCorrect
- CCorrelations are always negative between any two commodities
- DCorrelations within a sector are lower than across sectors because of shared supply drivers
Explanation
Commodities within a sector share supply and demand drivers, so correlations within a sector (e.g., crude and heating oil) are high. Across sectors, correlations are generally low. Claiming high cross-sector correlation or negative correlation everywhere is not supported.
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