Correlation between Islamic stock and Commodity markets: An investigation into the impact of financial crisis and financialization of commodity markets

Khan, Aftab and Masih, Mansur (2014): Correlation between Islamic stock and Commodity markets: An investigation into the impact of financial crisis and financialization of commodity markets.

Abstract

The repercussions of the recent financial crisis were felt over different parts of the world causing much calamity to different markets, economies and investors. The capital markets, in particular, took a severe hit during the crisis plummeting to all-time lows. However, before the crisis, the significant rise in commodity prices since 2002 and their subsequent fall since July 2008 have revived the debate on the role of commodities in the strategic and tactical asset allocation process. Therefore, the understanding of relationship between commodities and stock markets is crucial, especially during the crisis, when investors are looking for alternative investment opportunities. In this paper, we focus on commodity markets and their relation with Islamic stock markets during the recent financial crisis. This is the first attempt to study this relationship in the important and growing area of Islamic capital markets with the help of the recent dynamic conditional correlation (DCC) GARCH methodology. The focus of the study is to look into the dynamics of the correlations between both markets, and analyze whether those time-varying correlations evolve according to the situation—bullish or bearish—in the stock market. This paper investigates the links between price returns for 5 commodity sectors and Islamic stock market over the period from January 2001 to March 2013, by paying a particular attention to the Energy sector. We show that the correlations between commodity and Islamic stock markets evolve through time and are highly volatile, particularly since the 2007-2008 financial crises. The latter has played a key role, emphasizing the links between Islamic stock and commodity markets, and underlining the financialization of commodity markets. At the idiosyncratic level, a speculation phenomenon is highlighted for energy sector (oil), while the safe-haven role of precious metal sector (gold) is evidenced.

• Item Type: MPRA Paper
• Language: English
• Keywords: Islamic Capital Market, Commodity Market, Financial Crisis, Multivariate GARCH Dynamic Conditional Correlations.
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q43 - Energy and the Macroeconomy

References

Baur, D.G., McDermott, T.K. (2010), “Is gold a safe haven? International evidence”, Journal of Banking and Finance 34(8), 1886-1898.

Buyuk¸sahin, B., Harris, J.H. (2011), “Do speculators drive crude oil futures prices?” The Energy Journal 32(2), 167-202.

Capelle-Blancard, G., Coulibaly, D. (2011), “Index trading and agricultural commodity prices: A panel Granger causality analysis”, International Economics 126-127.

Chiou, J.S., Lee, Y.H. (2009), “Jump dynamics and volatility: Oil and the stock markets”, Energy 34(6), 788-796.

Choi, K., Hammoudeh, S. (2010), “Volatility behavior of oil, industrial commodity and stock markets in a regime-switching environment”, Energy Policy 38(8), 4388-4399.

Doyle, E., Hill, J., Jack, I. (2007), “Growth in commodity investment: risk and challenges for commodity market participants”, Financial Services Authority (FSA) Report, FSA Markets Infrastructure Department.

Du, X., Yu, C.L., Hayes, D.J. (2011), “Speculation and volatility spillover in the crude oil and agricultural commodity markets: A Bayesian analysis”, Energy Economics 33, 497-503.

Dwyer, A., Gardner, G., Williams, T. (2011), “Global commodity markets—Price volatility and financialisation”, Reserve Bank of Australia Bulletin, June.

Engle, R.F. (2002), “Dynamic Conditional Correlation - A Simple Class of Multivariate GARCH Models”, Journal of Business and Economic Statistics 20(3), 339-350.

Filis, G., Degiannakis, S., Floros, C. (2011), “Dynamic correlation between stock market and oil prices: The case of oil-importing and oil-exporting countries”, International Review of Financial Analysis 20(3), 152-164.

Hammoudeh, S., Dibooglu, S., Aleisa, E. (2004), “Relationships among U.S. oil prices and oil industry equity indices”, International Review of Economics and Finance 13(4), 427-453.

Jones, C.M., Kaul, G. (1996), Oil and the stock markets, Journal of Finance 51, 463-491.

Malik, F., Ewing, B.T. (2009), “Volatility transmission between oil prices and equity sector returns”, International Review of Financial Analysis 18, 95-100.

Manera, M., Nicolini, M., Vignati, I. (2012), “Returns in commodities futures markets and financial speculation: A multivariate GARCH approach”, Fondazione Eni Enrico Mattei, 23.2012.

Papapetrou, E. (2001), “Oil price shocks, stock market, economic activity and employment in Greece”, Energy Economics 23(5), 511-532.

Park, J., Ratti, R.A. (2008), “Oil Price Shocks and Stock Markets in the U.S. and 13 European Countries”, Energy Economics 30, 2587-2608.

Pesaran, B., and Pesaran, M.H. (2009), “Time Series Econometrics using Microfit 5.0”, Oxford: Oxford University Press.

Sadorsky, P. (1999), “Oil price shocks and stock market activity”, Energy Economics 21, 449-469.

Vivian, A.,Wohar, M.E. (2012), “Commodity volatility breaks”, Journal of International Financial Markets, Institutions and Money 22, 395-422.