Increasing Trends in the Excess Comovement of Commodity Prices

Abstract

In this paper, we investigate whether and how excess comovement among commodity returns i.e., correlation among commodity returns not accounted for by the common shocks of exogenous macroeconomic variables, have increased during these decades.

To this end, we generalize the model of excess comovement, originated by Pindyck and Rotemberg (1990) and extended by Deb, Trivedi, and Varangis (1996), to develop the STDCC (smooth-transition dynamic conditional correlation) model that can capture long-run trends and short-run dynamics in excess comovement. Using monthly commodity returns data from 1983 to 2011, we find significant increasing long-run trends in excess comovement have appeared since around 2000 in all pairs of agricultural raw materials, beverages, metals, and oils. We then examine the possibility of non-monotonic trends, and find that in most cases, excess comovement continue to increase even after the financial crisis in 2008 and hence the increasing trends in excess comovement among commodity returns are not an artifact produced by the recent financial crisis, but the intrinsic nature of the excess comovement during the period including the post-crisis era. We also confirm that the increasing long-run trends of excess comovement are robust to the change in the sensitivities of commodity returns to common macroeconomic factors. Moreover, unlike the results above, we find no significant increasing trends in excess comovements among off-index commodity returns. Finally, we find that our results are robust for global macroeconomic shocks. That is, taking account of global macroeconomic variables, we still find significant, though a bit weaker, long-run increasing trends in commodity excess comovement. Those findings provide additional evidence for the recent debates about the increasing commodity-return correlations.

Keywords: commodity; excess comovement; time-varying correlation; smooth transition model; DCC model; financialization

JEL Classification: C32, C51, G15