Working Paper: CEPR ID: DP9558
Authors: Annelaure Delatte; Claude Lopez
Abstract: In this paper, we propose to identify the dependence structure existing between the returns of equity and commodity futures and its evolution through the past 20 years. The key point is that we do not do not impose the dependence structure but let the data select it. To do so, we model the dependence between commodity (metal, agriculture and energy) and stock markets using a flexible approach that allows us to investigate whether the co-movement is: (i) symmetric and occurring most of the time, (ii) symmetric and occurring mostly during extreme events and (iii) asymmetric and occurring mostly during extreme events. We also allow for this dependence to be time-varying from January 1990 to February 2012. Our analysis uncovers three major stylized facts. First, we find that the dependence between commodity and stock markets is time varying, symmetric and occurs most of the time (as opposed to mostly in extreme events). Second, not allowing for time-varying parameters in the dependence distribution generates a bias toward evidence of tail dependence. Similarly, considering only tail dependence may lead to wrong evidence of asymmetry. Third, a growing comovement between industrial metals and equity markets is identified as early as in 2003, a comovement that spreads to all commodity classes and becomes unambiguously stronger with the global financial crisis after Fall 2008.
Keywords: commodity market; comovement; copula; equity market; tail dependence; time varying
JEL Codes: C20; F30; G10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Dependence between commodity markets and equity markets is time-varying (G10) | Dependence structure is symmetric and occurs most of the time (C69) |
| Failure to account for time-varying parameters in dependence distribution (C22) | Bias in suggesting tail dependence (C46) |
| Considering only tail dependence (C29) | Misleading conclusions about asymmetry in the relationship between returns (G40) |
| Strengthened comovement between industrial metals and equity markets (L61) | Increased integration of commodities with equity indices (G13) |
| Evolving nature of market linkages (D40) | Importance of allowing for time-varying relationships in financial analyses (C22) |