BIS Functioning Papers

No 420

On the correlation between commodity and equity returns: implications to get portfolio share by Ambito Lombardi and Francesco Ravazzolo

Monetary and Economic Division

July 2013

JEL classification: C11, C15, C53, E17, G17. Keywords: Commodity rates, equity rates, density predicting, correlation, Bayesian DCC.

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Financial institution for Worldwide Settlements 2013. All legal rights reserved. Quick excerpts can be reproduced or perhaps translated supplied the source is stated.

ISSN 1020-0959 (print) ISBN 1682-7678 (online)

Around the correlation among commodity and equity earnings: implications to get portfolio allocation∗ Marco M. Lombardi†Francesco Ravazzolo‡ This summer 11, 2013

Abstract In the recent years several commentators hinted at an boost of the correlation between value and commodity prices, and blamed investment in commodity-related products with this. First, this paper investigates such says by looking at various procedures of relationship. Next, all of us assess exactly what the ramifications of higher correlations between oil and value prices intended for asset portion. We build a time-varying Bayesian Dynamic Conditional Correlation unit for volatilities and correlations and find that joint modelling item and value prices produces more accurate stage and density forecasts, which will lead to significant benefits in portfolio allocation. This, nevertheless , comes at the buying price of higher stock portfolio volatility. Consequently , the popular look at that goods are to be included in one's stock portfolio as a hedge device is not grounded.

Keywords: Commodity prices, fairness prices, denseness forecasting, relationship, Bayesian THE BRAND. JEL Classiп¬Ѓcation: C11, C15, C53, E17, G17. We thank workshop participants with the BIS, as well as the ECB-NB " Building and predicting oil prices”, MMF " Understanding Essential oil and Commodity Prices”, and CAMP " Forecasting and Analysing Essential oil Prices” training courses for useful comments. All of us also gratefully acknowledge remarks by Lutz Kilian and Dubravko Mihaljek. This paper is area of the research actions at the Hub for Applied Macro and Petroleum economics (CAMP) by BI Norwegian Business Institution. CAMP is supported by Statoil's research put in petroleum economics. The manuscript was circulated initially while using title " Oil Selling price Density Forecasts: Exploring the Linkages with Share Markets”. The views portrayed in this daily news are our very own and do not necessarily reflect those of Bank for International Settlements and/or Norges Bank. †Bank pertaining to International Funds, Centralbahnplatz 2, CH-4002 Basel (Switzerland). Email: marco. [email protected] org ‡ Norges Bank and BI Norwegian Organization School, Bankplassen 2, NO-0107 Oslo (Norway). Email: francesco. [email protected] zero в€—

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Introduction

The past 10 years has experienced a broad-based surge in commodity rates, with petrol a frontrunner. The upward trend in prices has been ascribed to booming demand at the global level, nevertheless fluctuations around it have been substantial, specifically after the onset of the Great Downturn. Investing in commodities has generated hefty earnings and is now increasingly popular, regardless of the substantial risks linked to this type of expense, due to the natural volatility of commodity rates. Indeed, the majority of fund managers have began advising buyers to spend a discuss of their portfolios to commodity-related products as part of long-term diversification strategy. This is often motivated by fact that, in the long run, products are believed to display low...