The Effect of Economic Policy Uncertainty on Stock-Commodity Correlations and its Implications on Optimal Hedging

24 Pages Posted: 11 Sep 2018

See all articles by Ihsan Badshah

Ihsan Badshah

Auckland University of Technology

Riza Demirer

Southern Illinois University Edwardsville - Department of Economics & Finance; Economic Research Forum (ERF)

Tahir Suleman

Wellington Institute of Technology

Date Written: August 29, 2018

Abstract

Motivated by previous studies documenting significant return and volatility effects of economic policy uncertainty (EPU) on the stock market, this study examines whether EPU has an effect on the dynamic conditional correlations between stock and commodity returns. Our findings point to a positive and significant effect of EPU on stock-commodity correlations with particularly stronger effects in the case of energy and industrial metals. The EPU effect is stronger during weak economic conditions, while VIX as a proxy of market uncertainty is generally found to be insignificant. Finally, we show that the EPU effect on correlations has investment implications as well, implied by a significant effect on optimal hedge ratios in commodities in order to mitigate stock market risks. Our results underscore the importance of selective hedging strategies in which risk managers base the timing and size of their hedging programs on future price expectations, conditional on the level of policy uncertainty state and prevalent economic conditions.

Keywords: Commodity market, Policy uncertainty, Conditional correlation

JEL Classification: C22, C32, G14, G15

Suggested Citation

Badshah, Ihsan and Demirer, Riza and Suleman, Tahir, The Effect of Economic Policy Uncertainty on Stock-Commodity Correlations and its Implications on Optimal Hedging (August 29, 2018). Available at SSRN: https://ssrn.com/abstract=3240962 or http://dx.doi.org/10.2139/ssrn.3240962

Ihsan Badshah

Auckland University of Technology ( email )

3 Wakefield Street
Private Bag 92006
Auckland Central 1020
New Zealand
+64 9 9219999 Extn: 5394 (Phone)
+64 9 219940 (Fax)

Riza Demirer (Contact Author)

Southern Illinois University Edwardsville - Department of Economics & Finance ( email )

Department of Economics & Finance
Alumni Hall 3144
Edwardsville, IL 62026-1102
United States
(618) 650-2939 (Phone)
(618) 650-3047 (Fax)

HOME PAGE: http://www.siue.edu/~rdemire/

Economic Research Forum (ERF)

21 Al-Sad Al-Aaly St.
(P.O. Box: 12311)
Cairo, Cairo
Egypt

HOME PAGE: http://erf.org.eg/affiliates/riza-demirer-3/

Tahir Suleman

Wellington Institute of Technology ( email )

21 Kensington Ave
Petone, Wellington 5012
New Zealand

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