Academic journal article IUP Journal of Applied Finance

Empirical Relationship between Commodity, Stock and Bond Prices in India: A DCC Model Analysis

Academic journal article IUP Journal of Applied Finance

Empirical Relationship between Commodity, Stock and Bond Prices in India: A DCC Model Analysis

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

The relationship between stock, bond and commodity prices became more vibrant after the recent global financial crisis in 2008. It has been seen that financial investors had been more active in commodity market since the early 1990s but they were more concentrated on hedge funds, which provides short-term investment possibility. But after the dotcom crisis1 in 2000, a new paradigm of involvement was created among the financial investors. Basically, after the dotcom crisis in 2000, there has been a new proportion of involvement in commodity market, where most of the investors use swap agreement to take long-term position in commodity indices. Commodity price indices were composites of weighted prices of a broad range of commodities, including energy, agricultural products and metals (UNCTAD, 2009b). The financial investors invest in commodity indices to diversify their portfolios and to minimize risk with no physical transformation of commodities.

The recent global financial turmoil in 2008 gave a lesson to investors to diversify their portfolios from one market to another market. The portfolio diversification can be achieved through two main channels: firstly, diverting investment to different class of assets, which have a negative correlation, or secondly, investing in similar class of assets in multiple markets through international diversification (Cappiello et al., 2006). Therefore, the collapse of financial market in 2002 and 2008 has brought the attention of policy makers and investors to look into the relationship between stock price, bond price and commodity price in India. It is believed that commodity markets can be used for portfolio diversification. Therefore, different commodity price indices were developed in different commodity exchanges, which attract billions of dollars of institutional and wealthy individual investment (Tang and Xiong, 2010). In the above backdrop, this paper attempts to empirically examine the relationship between stock, bond and commodity prices in India.

Literature Review

Basically, the relationships between stock, bond and commodity prices are studied by financial economists and practitioners to carry out better portfolio diversifications. A very large number of studies are available on the relationship between stock price and exchange rate both for developed and developing countries. But few or no studies are found on the relationship either between stock and commodity prices or bond and commodity prices in India. To our knowledge, no studies are available on the relationship between stock, bond and commodity prices in India.

Empirical studies on the relationship between these prices are quite interesting as these studies are contradictory to each other. The studies like Ankrim and Hensel (1993) found that in the period of inflation commodity markets provide diversification for stock market. The relationship between the stock price and commodity prices is generally low. Lee et al. (1985) said that there is no relationship between the rates of return of the two series (commodity futures and stock) but commodity markets may be used in conjunction with an equity portfolio to help reduce risks and enhance portfolio returns. Jensen et al. (2000) said that in restrictive monetary policy, commodity futures are shown to have substantial weight in the efficient portfolios, with significant return enhancement at all levels of risk. But in expensive monetary policy period, commodities futures are shown to have little or no weight in the efficient portfolios, with no return enhancement at all levels of risk.

Miffre and Rallis (2007) said that the momentum returns are low with the returns of traditional asset classes, which give more strength to commodity markets for portfolio diversification. Chan et al. (2011) said that in the crisis period, investors seek to hold a component of Treasury bonds in their portfolios. …

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