Intelligent Portfolio Theory and Arbitrage in Commodity Futures

This paper presents a special form of the general Intelligent Portfolio Theory for arbitrage in commodity futures markets. The theory is based on the recognition of the reality that any single arbitrage strategy on any futures pair is bounded in rationality, so it is unable to keep exhibiting desirable performance consistently over time; thus an intelligent portfolio for arbitrage in futures markets consists of a number of selected futures pairs of which each pair is arbitraged via one or multiple dynamic strategies. Here integration test and correlation are used for selecting futures pairs, and Kalman filtering is used to model the trend of the price spread for each futures pair. In Chinese commodity futures markets, 32 futures are examined, from which up to 14 futures pairs are selected. This intelligent portfolio arbitrage system is tested on historical intraday data, and the result exhibits desirable performance with low maximum drawdown and high reward-to-risk ratio in comparison with individual futures pair arbitrages.