Impact of Price-Weighted Commodity Indices on Volatility

Very Hard Commodities Investment Commodity Indices

In the context of commodity investments, commodity indices serve as critical benchmarks for measuring the performance of various underlying commodities. These indices are typically structured to capture a diverse range of commodities while maintaining liquidity and minimizing idiosyncratic risks. However, the construction methodologies of commodity indices can significantly influence their performance and risk characteristics.

Consider the two main types of commodity indices: price-weighted and equal-weighted. Price-weighted indices allocate weights based on the prices of the underlying commodities, whereas equal-weighted indices allocate the same weight to each commodity, regardless of its price. Understanding these methodologies is crucial for investors when selecting commodity indices for investment.

Which of the following statements accurately describes a key impact of using a price-weighted commodity index?

Price-weighted commodity indices tend to exhibit greater volatility as high-priced commodities dominate the index's movements.

Price-weighted commodity indices are less sensitive to changes in the prices of lower-priced commodities, often underestimating their contribution to overall market performance.

Price-weighted commodity indices typically provide superior diversification compared to equal-weighted indices due to the equal representation of all commodities.

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