Commodity Dependence and Optimal Asset Allocation

We present a model to explain the diversification benefits of incorporating commodities into a portfolio of traditional assets from the perspective of domestic investors. Utilizing a sample of 38 countries from 2000 to 2020, we show that investors in high‐commodity dependence countries generally do not benefit from adding commodities to their portfolios while investors located in low‐commodity dependence countries usually do. Our results thus show that local contexts matter and that commodities may augment a diversified portfolio if investors are not excessively exposed to commodity risk through their country's economic structure.