Markets of One

Commodities and Equities:
Ever a “Market of One”?

Bahattin Büyükşahin, Michael S. Haigh,
and Michel A. Robe
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Bahattin As more money has chased (...) risky factors behind equity returns have histori-
Büyükşahin assets, correlations have risen. By the same cally had no forecasting power in commodity
is an economist at the logic, at moments when investors become markets (Erb and Harvey [2006]).
U.S. Commodity Futures
Trading Commission
risk-averse and want to cut their positions, Yet, arguments have long existed that
in Washington, DC. these asset classes tend to fall together. The equities and commodities should be nega-
bbuyuksahin@cftc.gov effect can be particularly dramatic if the tively correlated (e.g., Bodie [1976]; Fama
asset classes are small—as in commodi- [1981]). As an empirical matter, there is also
M ichael S. H aigh ties. (...) This marching-in-step has been evidence that commodity futures returns do
is a managing director
at K2 Advisors in
described (...) as a ‘market of one’. vary with systematic risk after controlling
Stamford, CT. The Economist, March 8, 2007.
for hedging pressures (Bessembinder [1992];
mhaigh@k2advisors.com de Roon, Nijman, and Veld [2000]; Khan,
Financial investors have sophisticated Khokher, and Simin [2008]).
M ichel A. Robe arguments to explain their stampede Almost all empirical studies of the rela-
is an associate professor into commodities. Many say they pro- tionship between equity and commodity
of finance at the Kogod
vide returns that are not correlated to returns are based on data series that end in
School of Business at
American University equities (…) improving a portfolio’s 2004 or 2005. In the last five years, however,
and a consulting senior diversification. two major changes have taken place in com-
economist at the U.S.
The Economist, August 20, 2008. modity markets.
Commodity Futures First, the first sustained world-demand-
W
Trading Commission in
Washington, DC. e provide detailed empirical driven commodity price shock of the last 20
mrobe@american.edu evidence on the extent to years started in 2004 (Kilian [2009]). His-
which the prices of, and the torically, the real prices of crude oil and equi-
returns on, passive invest- ties have moved (upward) in tandem only
ments in commodity and equity markets during episodes of growth in world demand
move in sync. We also ask whether the inten- for industrial commodities (Kilian and Park
sity of these co-movements has increased [2009]). Generalizing, it is an open question
over time. whether equities and commodities as a whole
One might expect commodities and started to move more in sync amid this com-
equities to not move in sync. There is no modity boom.
theoretical model of a common factor driving Second, not until 2003 did financial
the equilibrium relation between equity and institutions—including hedge funds and
commodity prices, and the traditional risk commodity index funds—sharply increase
their share of open interest in commodity
76 Commodities and Equities: Ever a “M arket of One”? Winter 2010
JAI-BUYUKSAHIN.indd 76 12/11/09 2:08:22 AM

futures markets (Büyükşahin, Haigh, Harris, Overdahl, We find statistically significant differences in the
and Robe [2008]). One reason why the large-scale arrival means and standard deviations of the rates of return
of these new types of traders could matter for pricing across the two asset classes and for each asset class, across
is that it made cross-market arbitrage easier (Başak and the three sub-periods. The evidence is more complex for
Croitoru [2006]) and, in the process, more closely linked cross-correlations. Simple correlations were only slightly
commodity and equity markets. Another channel for positive in the first two sub-periods (i.e., between 1992
tighter cross-market linkages is if financial institutions and 2003). They increased in economic and statistical
respond differently from traditional commodity traders significance between June 2003 and November 2008.
to large stock market movements—in particular, if sharp Market turmoil in summer and fall 2008 is responsible
downward movements in equity markets force financial for this increase: between June 2003 and May 2008,
investors to liquidate positions in commodity markets equity–commodity correlations had in fact fallen in
so as to raise cash for margin calls or for other risk- comparison to the first two sub-periods (had become
management reasons. The events of 2008 provide an slightly negative). We obtain qualitatively similar results
opportunity to examine this possibility. at all return frequencies.
In this article, we investigate empirically the rela- We show that time-varying measures of the cor-
tionships (or lack thereof ) between ordinary, as well as relations between equity and commodity return series
extreme, returns on passive investments in commodity f luctuate substantially throughout the sample period.
and equity markets. We use daily, weekly, and monthly The pattern of f luctuations, however, does not appear
returns from January 1991 (when GSCI commodity to change during the entire sample period. We establish
index investment products first became available) through these results with Engle’s [2002] dynamic conditional
November 2008. Overall, our results indicate that com- correlation (DCC) methodology. Using DCC allows us
modities provide substantial diversification opportunities to obtain dynamically correct correlations that, from the
to passive equity investors, but that this diversification perspective of an equity investor, are worth “around 60
did not work well when it was needed the most. basis points in annualized terms and (…) several hundred
We focus on the S&P 500 Index returns and GSCI on some days” (Engle [2002]).
total return data to proxy for the rates of return on We find that the range of values taken by DCC
representative unlevered investments in, respectively, estimates is indeed quite wide: weekly values, for
U.S. equities and commodities (we obtain qualitatively example, can be as low as –0.5 or as high as +0.5. Much
similar results with two other widely used indices—the of the time, however, the DCC estimates are close to 0.
Dow Jones DJIA equity and DJAIG total return com- Importantly, we find no evidence of a secular increase
modity indices). We run all of our analyses on the entire in correlations in the last few years. In particular, even
sample period and on three successive sub-periods: June though the correlations between equity and commodity
1992 to May 1997; June 1997 to May 2003; and June returns increased sharply in fall 2008 amid extraordinary
2003 to November 2008. The first sub-period wit- economic and financial turbulence, they remained lower
nessed economic expansion and predates the commodity than their peaks in the previous decade.
investment boom. The second sub-period includes an Correlation estimates are relevant to short-term
economic contraction as defined by the National Bureau investors. For long-term investors, the key issue is whether
of Economic Research. More importantly, June 1997 there exists a long-term relation between the prices of
to May 2003 captures the Asian crisis; Russian and commodities and equity investments even though these
Argentinean sovereign defaults; and the U.S. internet prices may diverge in the short term (Kasa [1992]). To
bubble and its aftermath. The third sub-period saw answer this question, we apply recursive cointegration
financial traders greatly increase their participation in techniques ( Johansen [1998, 1991]; Johansen and Juselius
commodity futures markets. Much of that period was [1990]). Except for a short period in the late 1990s, we
characterized by strong worldwide economic growth, find little statistical evidence of cointegration—and none
but it ended with financial and economic mayhem. These in the last nine years. The implication is that passive
sub-periods help visualize whether overall economic and investors can still achieve substantial gains by diversi-
financial conditions affect the co-movements between fying portfolios across the two asset classes.
commodities and equities.
Winter 2010 The Journal of A lternative Investments 77

Although we find no evidence of a structural shift Related Work
in correlation and cointegration levels, it could still be the
case that financial and commodity markets are a “market A number of papers study the relationship between
of one” during extreme events. Hartmann, Straetmans, and equity and commodity returns. Closest to our endeavor,
de Vries [2004], for example, find evidence of cross-asset several examine time variations in that relationship (e.g.,
extreme linkages in the case of bond and equity returns Gorton and Rouwenhorst [2006]; Huang and Zhong
from the G-5 countries. Using a different approach, [2006]; Kat and Oomen [2007]). Most of those studies
Longin and Solnik [2001] document that international end in 2004 or 2005 and, hence, do not include the
equity market correlations increase in bear markets. period when much of the growth in commodity invest-
ment took place. An exception is a contemporaneous

Here, we first identify the days and weeks during

which returns on equity indices were at least one or two study by Chong and Miffre [2009], which includes data
standard deviations away from their means and then ana- through 2006. Our article complements those studies
lyze the contemporaneous returns on investable com- in two ways.
modity indices. Contrary to extant findings on extreme First, we include all five years characterized by
linkages between other asset markets, this first analysis the large-scale presence of financial intermediaries
identifies few links between exceptionally large returns in commodity markets. Our results suggest that the
on equities and on commodities. This is true for the entry of these new kinds of traders was not immedi-
whole sample period as well as all three sub-periods; for ately accompanied by an increase in equity–commodity
positive as well as negative exceptional returns; and for co-movements.2 This finding complements the obser-
periods of stock market upturns as well as downturns. vation that, despite increased capital f lows to emerging
Next, we use a methodology similar to that of markets in the years following their financial liberaliza-
Longin and Solnik [2001] to analyze equity–commodity tion and despite greater integration with world equity
linkages when the returns on equity and commodity markets, return correlations across international equity
indices both take values in a given tail of their respec- markets did not increase enough to diminish the benefit,
tive distributions. From 1991 to May 2008, we find to U.S. investors, of diversifying into emerging market
weak extreme-event correlations. Interestingly, the cor- stocks (Bekaert and Harvey [2000]; Carrieri, Errunza,
relation between equities and commodities during this and Hogan [2007]).
period was negative in the joint lower tail. This finding Second, our article is the f irst to assess co-
highlights another aspect of the diversification benefits movements between equities and commodities over
that commodities provided to equity investors between the long term (by means of cointegration analyses) and
1991 and May 2008. during weeks and days of market stress (by means of
Once we include the summer and fall of 2008, extreme-returns analyses). The cointegration analysis
however, we find that the equity–commodity correla- supports the intuition that passive long-term investors
tions are positive in both the upper and lower tails. In can still gain by diversifying portfolios across the two
particular, conditional on both equity and commodity asset classes. The extreme-event analysis provides evi-
returns being very poor, the two return series are posi- dence that there is something unique about the summer
tively correlated. From a portfolio diversification per- and fall of 2008. Crucially, it warns that the diversifica-
spective, our findings suggest that the “commodity tion benefits of commodities might very well be weaker
umbrella” leaks during heavy storms. precisely when they are most needed.
Many academics and practitioners have long called
for substantial allocations to commodities as an asset class Data and Descriptive Statistics
for the purposes of return generation and portfolio diver-
sification.1 Our finding, that the co-movements between We take the perspective of a passive investor when
equities and commodities have in general not increased in analyzing the relationship between commodities and
the last five years, suggests that commodities retain their equity investments. Modern portfolio theory suggests
role as a diversification tool. This conclusion is tempered, that the relevant information matrix for such an investor
however, by our finding that those benefits may not be includes the expected asset returns, the variances of these
as strong when diversification would help the most. returns, as well as cross-asset correlations.

To assess short-term correlations, we use daily, (19.79% annualized) in the next five years, before turning
weekly, and monthly returns and return volatilities dramatically negative in fall 2008. The drop was steep:
on four widely used commodity and equity indices.3 The average weekly rate of return on the GSCI goes from
We focus on results for weekly holding-period returns 0.35% between June 2003 and May 2008 to only 0.078%
(Tuesday close to Tuesday close) and brief ly discuss our between June 2003 and November 2008.
(qualitatively similar) findings for daily and monthly The corresponding figures are very similar for the
returns. To analyze long-term cointegration, we use the DJAIG total return commodity index—with two excep-
Tuesday settlement prices for the same four indices. tions. One exception is the first sub-period (1992–1997),
For equities, we use the S&P 500 Index. In robust- when the average weekly return was 0.205% for the
ness checks, we use the DJIA index.4 For commodities, DJAIG versus 0.138% for the GSCI. Exhibit 2, which
we use the unlevered total return on the S&P GSCI plots the levels of the four indices, indeed shows that the
(formerly, the Goldman Sachs Commodity Index), i.e., GSCI did not start appreciating until the end of 1996,
the return on a “fully collateralized commodity futures whereas the DJAIG started appreciating in 1994. The
investment that is rolled forward from the fifth to the second exception is in the third sub-period. Exhibit 2
ninth business day of each month.” The GSCI covers shows that, although the two indices did grow in sync
24 commodities but is heavily tilted toward energy during much of that period (their mean rates of return are
because its weights ref lect world production figures. For close: 0.076% for the DJAIG and 0.078% for the GSCI),
robustness checks, we use total (unlevered) returns on there are two episodes when they diverged: the second
another widely used investable benchmark, the Dow- half of 2006, when the GSCI rose while the DJAIG
Jones DJ-AIG total-return commodity index (hence- dropped rather substantially; and the first half of 2007,
forth, DJAIG). This rolling index, which covers 19 when the DJAIG surged (nearly catching up to the GSCI
physical commodities, was designed to provide “a diver- level by end-2007).
sified benchmark for the commodity futures market.” During the entire sample period, the weekly rate
We find similar results with both indices. of return on the S&P 500 equity index was higher than
We also analyze possible changes in the relationship
between equities and specific types of commodities. For
this purpose, we use daily, weekly, and monthly total Exhibit 1
returns on investable sub-indices representing key com- Weekly Rates of Return—Summary Statistics,
ponents of the GSCI: Energy, Non-Energy, Industrial January 1991 to November 2008 (%)
Metals, Precious Metals, Agriculture, and Livestock.
The price data for all four indices (GSCI, DJAIG,
S&P 500, and DJIA) and for the six sub-indices are from
Bloomberg, from January 1991 to November 2008. We
also provide results for June 1, 1992, to May 31, 1997;
June 1, 1997, to May 31, 2003; and June 1, 2003, to
November 18, 2008.
Returns on Equity and Commodity Indices
Exhibit 1 presents some descriptive statistics for the

weekly rates of return on two equity and two com-
modity indices.5 From January 1991 to November 2008,
Notes: Exhibit 1 provides summary statistics for the unlevered rates of
the mean weekly total rate of return on the GSCI was return on the Dow Jones Industrial Average (DJIA) and S&P 500 equity
0.078% (4.14% in annualized terms), with a minimum indices (excluding dividends), as well as on the Dow Jones DJAIG and
of –14.59% and a maximum of 11.20%. The typical rate S&P GSCI commodity indices (total return). This exhibit uses sample
of return varies sharply across the sample period: it aver- moments computed using weekly rates of return (precisely, changes in log
prices multiplied by 100) from January 2, 1991, to November 11, 2008.
aged 0.14% in 1992–1997 (7.45% annualized); 0.045% in *** means that normality of the return distribution is rejected at the 1%
1997–2003 (2.36% annualized); and jumped to 0.35% level of statistical significance.

Exhibit 2 We find patterns for daily and monthly returns
Major Commodity and Equity Indices, 1991–2008 similar to those for weekly returns:
• Between January 1991 and November 2008, the

rates of return on commodity indices were on
average lower than those on equity indices.
• The rank-ordering of returns on these two asset
classes f luctuated dramatically over the course of
the sample period. In particular, equity returns
trounced commodity returns in 1992–1997, but

the reverse was true in 2003–2008.
• Among the four indices, the rates of return on
the GSCI are the most volatile throughout the
entire sample period. Of note, the GSCI rates
of returns are approximately 40% to 50% more
volatile than those on the DJAIG.
• The rates of return on equities are somewhat
more volatile than those on a well-diversified
basket of commodities (represented by the
DJAIG)—except in the last five years (2003–
2008). This caveat cannot be attributed to the
commodity market crash in the second half of
2008.
Note: The base level is set for January 2, 1991.
Simple Cross-Asset Correlations:
on commodities: 0.11% on average (6.03% in annualized Returns and Return Volatilities
terms), with a minimum of –15.77% and a maximum of
12.37%. The lowest absolute, mean, and median weekly Exhibit 2 gives some insights into the co-movements
rates of return on both commodity indices were all in between the commodity and equity indices. It suggests
the second sub-period; in contrast, the S&P 500 equity a highly positive correlation between the two equity
index had its highest absolute and median weekly rates indices; a positive, but somewhat weaker, correlation
of return during that time period. In a similar vein, between the two commodity indices; a weak or even
while the highest equity returns took place in the first or possibly negative correlation between the equity and
second sub-periods, the highest weekly returns on com- commodity indices, especially between June 1997 and
modity indices were realized in the third sub-period. May 2003 and in the first half of 2008; and highly posi-
These observations suggest that equities and commodi- tive cross-markets correlations in fall 2008.
ties do not move together. Exhibit 3 quantifies these first impressions by
Consistent with the fact that the DJAIG is by computing simple correlations between our four weekly
construction more diversified than the GSCI, the stan- return series. This exhibit is also helpful for the inter-
dard deviation of the weekly rates of return was much pretation of our empirical results. Panel A of Exhibit 3
lower in 1991–2008 for the DJAIG (1.96%) than for covers the entire sample. Panels B to E provide correla-
the GSCI (2.86%). This pattern of approximately 40% tions for different sub-periods.
to 50% greater GSCI volatility is observed in all three As expected, the simple correlation between the
sub-periods: 1.81% vs. 1.26% in 1992–1997; 2.88% vs. rates of return on the DJIA and S&P 500 equity indices
1.88% in 1997–2003; and 3.63% vs. 2.59% in 2003– is very high (more than 0.94 for the whole sample).
2008. Standard deviations increase in each of the suc- The correlation between the rates of return on the
cessive sub-periods for commodities, whereas they are two commodity indices is also very high: at all three
highest in the second sub-period for equities. return frequencies (daily-weekly-monthly), their simple

Exhibit 3 simple cross-correlation were even lower
Weekly Correlations—Rates of Return on Equity and (indeed, many became negative) between 2003
Commodity Indices and May 2008 (Panel D).
ii. In the case of daily returns, simple correlations
ranged from –0.0615 to 0.0014, depending on
the commodity–equity index pair and time
sub-period. For monthly returns, simple equity–
commodity correlations are not statistically
significantly different from zero for the entire
sample period.6
iii. Exhibit 2 suggests that, to the extent that the
correlations were at all positive prior to 2002,
the likely reasons are joint run-ups in com-
modity and equity prices in 1995–1997 and
again in the 18-month period from late 1998
through Spring 2000.
• On the other hand, equity–commodity correlations
increased sharply during the dramatic events of fall
2008: the same cross-correlations that were nega-
tive between June 2003 and May 2008 (Panel D
of Exhibit 3) instead become economically and
statistically significantly positive when we extend
our third sub-period to include June to November
2008 (Panel E of Exhibit 3).
The evidence regarding volatility correlations

(Exhibit 4) is strikingly similar to that regarding return
correlations (Exhibit 3). Exhibit 4 shows the simple
cross-correlations between the volatilities of the weekly
unlevered rates of return on all four investable indices
for the full sample (Panel A) and various sub-periods
(Panels B through E).
Note: *, **, or *** indicate that an estimate is statistically significantly different
from zero at the 10%, 5%, or 1% levels, respectively. • The cross-correlation between the volatilities of
the rates of returns on passive equity and com-
correlation is about 0.91 for the whole sample; it is stron- modity investments was close to zero between 1991
gest in 1997–2003 but slightly weaker in 1992–1997. and May 2008 (Panels B through D of Exhibit 4).
The evidence is more complex regarding the cross- These correlations were even slightly negative
correlations between the rates of return on passive equity (though not statistically significant) between June
and commodity investments: 1992 and May 1997 (Panel B) and between June
2003 and May 2008 (Panel D).
• On the one hand, equity–commodity correlations • However, a comparison of Exhibit 4’s Panel D
are usually very low and are at times negative. This against Panel E shows that commodity and equity
fact holds for daily, weekly, and monthly returns: volatilities jointly soared during the late summer
and fall of 2008.
etween 1992 and 2003, the “highest” weekly-
i. B
return correlations were a mere 0.09 to 0.13
In short, despite widespread perceptions that
(Panels B and C of Exhibit 3). Many of those
equity and commodity prices moved in tandem after

Exhibit 4 sub-indices representing key components of the S&P
Correlations between Weekly Adjusted-Return GSCI: GSCI Energy, Non-Energy, Industrial Metals,
Volatilities Precious Metals, Agriculture, and Livestock. Exhibit 5
focuses on weekly returns because the results are similar
for daily and monthly returns.
Over the entire sample period, investing in
Energy or Metal sub-indices yielded greater average
returns (though also more volatility) than investing in
other commodity sub-indices. However, performance
rankings vary significantly from period to period. Indus-

trial Metals and Precious Metals, for example, under-
perform all other sub-indices between 1992 and 1997,
but the situation is reversed between 2003 and 2008.
Agriculture, in contrast, outperformed all other sub-
indices in 1992–1997 but was the worst performer in
1997–2003 and in 2003–2008.
Simple Correlations:
Returns and Volatilities
Exhibit 6 shows the simple correlations between

the weekly unlevered rates of return on the S&P 500,
the S&P GSCI, and the six specialized commodity
benchmarks. Four patterns emerge:
• Equity returns exhibit statistically significantly

positive, but generally very small, correlations
with the returns on most of the commodity sub-
indices.
• The sole exception is Precious Metals, which pro-
vided diversification benefits to equity investors
Notes: Volatilities are computed by squaring the weekly changes in log prices,
net of the relevant period’s mean change, and multiplying the result by 10,000. throughout 1991–2008 (including the second half
*, **, or *** indicate that an estimate is statistically significantly different from of 2008).
zero at the 10%, 5%, or 1% levels, respectively. • The highest weekly correlation is with Industrial
Metals. That correlation is only 0.19 over the whole
2003, the simple cross-correlations between com- sample but increases to 0.33 in 2003–2008.
modity and equity returns (and between their volatili- • Consistent with the fact that the GSCI is heavily
ties) were in reality almost zero until May 2008. This weighted toward energy, the returns on the
finding is tempered by the fact that cross-correlations GSCI and on the Energy sub-index are very
increased precisely when equity investors needed the highly positively correlated—between 0.94 and
benefits of diversification into commodities the most— 0.98 depending on the sub-period. In contrast,
fall 2008. the correlation between the returns on the GSCI
index and those on the Non-Energy sub-index
range from 0.41 to 0.56 depending on the sub-
eturns on Specific Categories
R
period.
of Commodities
• The returns on the Non-Energy sub-index are posi-
Exhibit 5 provides summary statistics for the tively correlated with the returns on the underlying
unlevered (total) weekly rates of return on six investable

Exhibit 5
Weekly Rates of Return, Commodity Sub-Indices—Summary Statistics, January 1991 through November 2008 (%)
Note: *** means that normality of the return distribution is rejected at the 1% level of statistical significance.
Exhibit 6
Weekly Correlations—Rates of Return on Commodity Sub-Indices, January 2, 1991, to November 11, 2008
Note: *, **, or *** indicate that an estimate is statistically significantly different from zero at the 10%, 5%, or 1% levels, respectively.
components, hinting at a common economic vari- Short-Term Co-Movements

able driving returns on non-energy commodities.
The unconditional return volatilities, as measured
In addition to the return correlations between by the standard deviations of returns, vary substantially
equity and commodity sub-indices, a relevant piece of over time. For example, the weekly rates of return on
information for investors is the correlations between equities were 50% more volatile in 2003–2008 than in
the return volatilities of those assets from Exhibit 7. 1992–1997 (detailed exhibits are available upon request).
Exhibit 7 reinforces the notion that the correlation Strikingly, the standard deviation of the returns on com-
between the volatilities of equities and commodities modity investments doubled over the sample period.
is typically very low and almost never statistically sig- In contrast, Exhibit 3 might leave the impression
nificantly different from zero—except during a major that the unconditional correlations between the rates of
financial and economic crisis. returns on equity and commodity investments vary only

Exhibit 7
Return Volatility Correlations for Equities and Commodity Sub-Indices, 1991–2008
Note: *, **, or *** indicate that an estimate is statistically significantly different from zero at the 10%, 5%, or 1% levels, respectively.
mildly from sub-period to sub-period, and that these cor- first step, time-varying variances are estimated using
relations are typically close to zero, although the second a GARCH model. In the second step, a time-varying
half of 2008 was characterized by high correlations. correlation matrix is estimated using the standardized
However, before concluding that commodities residuals from the first-stage estimation.
usually provide a good hedge for equity portfolios (and Exhibit 8 presents the estimates of the GARCH-
that, in this respect, the fall of 2008 was an exceptional DCC(1,1) models. The AR(1) term in the mean equation
period), one should properly account for time variations is in general not statistically significant at any standard
in the various moments of the return series. We use level of significance. In the variance equations, all our
Engle’s [2002] DCC methodology to obtain dynami- shock-squared terms and lagged conditional variance
cally correct estimates of the intensity of co-movements terms are statistically significant, which is consistent
between commodities and equities. with time-varying volatility and provides empirical
justification for a GARCH(1,1) estimation. Further-
Methodology more, the coefficient on the conditional variance terms
is close to one, which suggests that volatility is highly
Measuring the relationship between variables at persistent.
various points in time, rather than using a single cor- The quasi-maximum likelihood estimation
relation coefficient over the entire sample period or a of GARCH(1,1) parameters yields ϕ 1=0.0369 and
few sub-periods, provides information on the evolution ϕ2 =0.9376. Both estimates are highly significant (stan-
of the relationship over time. dard deviations are 0.0004 and 0.0008, respectively).
For this purpose, simple correlation measures such as The estimate of ϕ 2 is close to 1, which suggests that
rolling historical correlations and exponential smoothing correlations should be highly persistent. Yet, as we now
are widely used. Neither technique, however, accounts show using Exhibits 9 to 11, the conditional correlations
adequately for changes in volatility. The sensitivity of the display considerable variation over time. All plots in
estimated correlation to volatility changes restricts infer- Exhibits 9 through 11 are drawn using DCC estimated
ences about the true nature of the relationship between by a log-likelihood for mean-reverting model.
variables, especially during high volatility periods.
The dynamic conditional correlation (DCC) Equities and Commodities
model developed by Engle [2002] helps to remedy this
problem. It is based on a two-step approach to estimating Exhibit 9 plots DCC estimates of the time-varying
the time-varying correlation between two series. In the correlations between the weekly unlevered rates of

Exhibit 8
Estimation Results from the GARCH-DCC(1,1) Model
Notes: Standard errors in parentheses. Return Equation: r t = μ0 + μ1r t-1 + ut; Variance Equation: ht = γ 0 + γ 1ut2-1 + γ 2ht -1 ; where, r t is the standardized
log return, and ht = Var t-1 [ut] denotes conditional variance. *, **, or *** indicate that an estimate is statistically significantly different from zero at the 10%,
5%, or 1% levels, respectively.
return on an equity index (S&P 500) vs. the rates of • The correlation between equity and commodity
return on two investable commodity indices (GSCI, returns f luctuates notably over time. The DCC
Panel A; DJAIG, Panel B).7 The sample period is Jan- time patterns are similar, independent of the spe-
uary 1991 to November 2008. The straight line running cific choices of equity (S&P 500 or DJIA) and
through each graph shows the relevant simple correla- commodity (GSCI or DJAIG) indices.
tion from Exhibit 3, which is not an average of any of • The correlations between equities and commodi-
the four time-varying correlation estimates. Exhibit 9 ties are not often greater than 0.30. In contrast,
highlights several facts: the correlation between the two equity indices is
typically well above 0.90 (plot not shown).

Exhibit 9
Equity and Commodity Weekly Return Correlations, January 2, 1991, to November 13, 2008
Notes: This exhibit depicts the time-varying correlation between the weekly unlevered rates of return (precisely, changes in log prices) on the S&P 500 (SP)
equity index and, respectively, S&P GSCI total return (GSTR, Panel A) and DJAIG total return (DJTR, Panel B) commodity indices from. DCC is
estimated by log-likelihood for mean reverting model (DCC_MR, Engle [2002]). Straight lines through each graph show the unconditional correlations.
• Consistent with the conclusions based on simple in fall 2008 amid extraordinary economic and
correlations, we find no evidence of a secular financial turbulences, they were lower than their
increase in DCC since 1991. In particular, DCC peaks in the previous decade.
estimates are not generally higher after 2002 than
they were in prior years. The pictures for daily and monthly returns are
• Most remarkably, although the correlations between similar to Exhibit 9. In sum, equity–commodity return
equity and commodity returns did increase sharply pairwise correlations f luctuate over the sample period.

Exhibit 10
Return Correlations, S&P 500 vs. Energy and Non-Energy Indices, January 2, 1991, to November 13, 2008
Notes: This exhibit plots the time-varying correlations between the unlevered (“total”) weekly rates of return on the S&P 500 (SP) equity index and six
investable commodity products. DCC is estimated by log-likelihood for mean-reverting model (DCC_MR, Engle [2002]). Straight lines through the graphs
show unconditional correlations. GSTR = GSCI total return index; GSENTR = GSCI Energy; GSNETR = GSCI Non-Energy; DJNETR = DJAIG
Non-Energy; DJENTR = DJAIG Energy; DJTR = DJAIG.

Exhibit 11
Return Correlations, S&P 500 vs. GSCI Sub-Index
Notes: This exhibit plots estimates of the time-varying correlation between the unlevered weekly rates of return on the S&P 500 (SP) equity index and four
investable GSCI total return commodity sub-indices. The DCC estimation method and sample period are the same as in Exhibit 10. Straight lines through
the graphs show the unconditional correlations. GSTR = GSCI total return index; GSIMTR = GSCI Industrial Metals total return index; GSPMTR =
GSCI Precious Metals total return index; GSLVTR = GSCI Livestock total return index; GSAGTR = GSCI Agriculture total return index.
The DCC estimates are negative most of the time but rates of return on the benchmark S&P 500 equity index
surge on occasion. These findings underline the impor- and on specific categories of investable commodity
tance of accurately measuring the co-movement between indices. Exhibit 10 focuses on the difference between
asset returns necessary for portfolio optimization. “Energy” and “Non-Energy” commodity baskets, for
the GSCI (left-hand side) and DJAIG (right-hand side).
Commodity Sub-Indices Exhibit 11 refines Exhibit 10 by breaking down the GSCI
Non-Energy index further into four investable sub-
Exhibits 10 and 11 complement the foregoing anal- indices: Precious Metals, Industrial Metals, Agriculture,
ysis by plotting estimates of DCC between the unlevered and Livestock. Exhibits 10 and 11 highlight three facts:

• There is a substantial amount of time variation in order. As is common, we estimate a vector autoregression
the correlations between returns on equities and using the undifferenced data and then use the Schwarz
on both the Energy and Non-Energy commodity information criterion to determine the optimal lag (2 in
sub-indices. These correlations f luctuate between our case). The Johansen procedure then estimates a
–0.40 and 0.45. vector error correction model (VECM) to determine the
• Unlike Energy, indices based on narrow non-energy number of cointegrating vectors. The final step entails a
categories exhibit less correlation with equities likelihood ratio test, called the trace test, to identify the
than the overall Non-Energy index, suggesting possible presence of a common factor driving commodity
possible diversification opportunities.8 and equity returns over the long run.
• Finally, and importantly, there is no obvious sec- Exhibit 12 shows the cointegration rank between
ular pattern toward an increase in correlations in the S&P 500 and GSCI indices for the full sample
2003–2008. period. Trace statistics suggest the absence of any cointe-
grating vector between commodity and equity indices.
Long-term Co-Movements This result is consistent with the low correlation that
we observe from our dynamic conditional correlation
The foregoing analysis suggests that, amid the estimation.
2003–2008 commodity and commodity investment
booms, dynamic correlations between the equity and Recursive Cointegration Analysis
commodity return series did not increase. The very fact
that our correlation estimates f luctuate significantly over Exhibit 12 indicates the absence over our 1991–
time, however, is evidence of their short-term nature. 2008 sample period of a long-term relationship between
Hence, another methodology is required if there is a commodity and equity indices. We now turn to the
reason to suspect that equity and commodity returns possibility of changes over time in the extent of a rela-
should move together in the longer run—for example, tionship, if any, between our indices.
given extant empirical evidence that returns on indi- To identify any such change, we use the recursive
vidual commodity futures vary with systematic (i.e., cointegration method outlined in Hansen and Johansen
market) risk. [1993]. The logic behind this technique is similar to
Johansen’s [1988] multivariate cointegration approach.
Cointegration Analysis In a first stage, the short-run parameters of the error-cor-
rection-model (ECM) are estimated using data from the
Before assessing long-run relationships between entire sample. In a second stage, we recover the “R-rep-
equities and commodities, we perform stationarity tests resentation” of the ECM: the short-run parameters are
employing the Augmented Dickey-Fuller (ADF) unit kept fixed to their full sample values and, instead of using
root tests. These tests show that both variables under all observations, the long run parameters are re-estimated
consideration (the S&P GSCI total return commodity using progressively more data.
index and S&P 500 equity index) are integrated
of order one. That is, they are non-stationary but
become stationary after taking first differences. Exhibit 12
To determine whether there exists a long-run Johansen Cointegration Analysis between S&P GSCI Total
relationship between our variables (notwithstanding Return Index and S&P 500 Index, Full Sample (1991–2008)
possible short run deviations from the hypothetical
equilibrium), we therefore employ a time-series
technique appropriate for non-stationary yet pos-
sibly co-integrated data series: Johansen’s multivar-
iate approach to co-integration analysis ( Johansen
[1988, 1991]; Johansen and Juselius [1990]). Notes: The VAR specification includes unrestricted constant and two lags.
The Johansen procedure involves several stages. *Small sample corrected trace test statistic; **Approximate p-value using the small
In a nutshell, the first step involves the choice of lag sample corrected trace statistic.

We start with the first 52 weeks of obser- Exhibit 13
vations and calculate the trace for this sub- Recursively Calculated Trace Test Statistic, 1992–2008
sample.9 We then increase the sample size by
one week and calculate the relevant trace sta-
tistics for this enhanced sample. This process
continues until we exhaust all the observations.
Of course, the trace statistic in the final stage
equals the standard static trace statistics calcu-
lated with the Johansen [1998] method. The
recursive method, however, allows us to see the

dynamics of the trace statistic.
Exhibit 13 shows the R-1 form of the trace
statistic, recursively calculated and re-scaled by
the 5% critical value.10 A normalized value above
one suggests the rejection of the null hypothesis
of no cointegration at the 5% level of signifi-
cance. The slope of the re-scaled trace statistic
determines the direction of co-movements
between our variables. An upward slope indi-
cates rising co-movement, while a downward
slope for the trace statistic reveals declining co-
movement between our variables.
Notwithstanding ample f luctuations in
the trace statistics during our sample period, Notes: This exhibit shows the R-1 form of the trace statistic (cointegration between Tuesday
Exhibit 13 highlights three distinct periods: S&P 500 and GSCI index levels), calculated recursively from January 1992 to November
2008. The 5% critical value is the horizontal line at 1. 1991 weekly index values are
utilized to launch the recursive procedure.
• From January 1992 to May 1997, a rela-
tively stable trace statistic generally stood equity indices and no evidence of secular strengthening
below the threshold level of one (implying no of any such trend. An implication is that passive investors
cointegrating relationship). are likely to achieve gains over the long run by diversi-
• From June 1997 to May 1999, the trace statistic fying portfolios across the two asset classes.
was unstable. It was generally above one, consti-
tuting some support for co-movement between our
Extreme Events
indices. However, during that two-year period, the
extent of co-movement varied and the statistical We have shown that neither the average levels of
significance of the trace was mixed. correlation between equity and commodity returns nor
• From June 1999 through the end of 2008, there is the patterns of variation of these correlations over time
no statistical evidence of any long-run relationship have been qualitatively very different in the last 5 years
between the benchmark commodity and equity than in the preceding 10 years. The widespread per-
indices. ception that financial markets nowadays move much
more in lock-step, however, could be due not to changes
These results are robust, in that we obtain simin average levels and patterns but, instead, to the joint
ilar findings with our alternative commodity index behavior of different assets on “stressful days.” In this
(DJAIG total return index) and with the Energy as well section, we provide evidence on equity–commodity co-
as the Non-Energy commodity sub-indices (figures not movements during periods of exceptionally large returns
shown). on commodities and equities.
In summary, there is little evidence of a common
long-term trend between investable commodity and

Summary Statistics Exhibit 14
Large or Extreme Weekly Co-Movements: S&P 500
To assess whether cross-asset extreme linkages exist
versus GSCI
in the case of commodities, we first identify the days
and weeks during which the returns on the benchmark
S&P 500 equity index were either one or two standard
deviations above or below its sample mean, and then
we analyze the contemporaneous unlevered returns on
the benchmark investable commodity index, the S&P
GSCI. Implicit in this approach is the notion that, if

changes in extreme linkages have taken place because of

commodity investment f lows, then the fact that equity
markets are much larger than commodity markets sug-
gests that ripple effects are more likely to emanate from
the former than from the latter. For the same reason,
liquidity problems or panics are more likely to spread
from stock to commodity markets than the reverse.
As in the rest of the article, we look at joint com-
modity-equity return behaviors for the whole sample
and three sub-periods. Exhibit 14 summarizes our find-
ings for weekly returns; an exhibit with the (qualitatively Notes: This exhibit focuses on episodes when the weekly return on the S&P 500
index was at least one standard deviation (“Large” returns, Panel A) or two
similar) daily results is available upon request. Panel A in standard deviations (“Extreme” returns, Panel B) away from its mean during a
Exhibit 14 tallies the episodes when the weekly return given period. Shown in italic is the number of times when the unlevered return
on the S&P 500 equity index was “large”—i.e., at least on the GSCI index was positive or negative for a given direction of the large
(Panel A) or extreme (Panel B) S&P return. Show in bold is the number of times
one standard deviation away from its mean during a when the contemporaneous GSCI return itself was also at least one (Panel A) or
given period. Panel B tallies what happens on weeks two (Panel B) standard deviations away from its sample mean.
of “extreme” stock returns—i.e., when these returns
were at least two standard deviations away from the the S&P 500 drops by a large amount, it is not clear
relevant mean. Exhibit 14 shows in italic the number which way the GSCI return will go, neither in terms of
of times when the unlevered return on the GSCI index its sign nor in comparison to its mean. A similar pattern
was positive or negative, for a given direction of the emerges when equities do very well. To wit, in the 120
large (Panel A) or extreme (Panel B) S&P 500 return. (50 + 70) weeks when the S&P 500 return exceeded
We show in bold the number of times when the con- its sample mean by one standard deviation or more, the
temporaneous GSCI return itself was also more than GSCI total return was positive 70 times but negative
one (Panel A) or two (Panel B) standard deviations away 50 times. Likewise, in the 18 weeks when the S&P 500
from its own sample mean. return exceeded its mean by more than two standard
Between June 1, 1992, and November 18, 2008, deviations, the GSCI total return was extremely bad four
there were 126 weeks (71 + 55) when the rate of return times and extremely good only three times.
on the S&P 500 equity index was below its sample mean In sum, contrary to extant findings that there
by one standard deviation or more and 21 weeks (15 + 6) exists extreme linkages between other asset markets
when the same return was below its mean by more than (e.g., Hartman et al. [2004]; Solnik and Longin [2001]),
two standard deviations. During the 117 weeks of large, Exhibit 14 is suggestive of little relationship between
poor S&P 500 returns, the total return on the GSCI exceptionally large returns on commodities and equi-
was positive (though not necessarily large or extreme) ties. The evidence is similar for the whole sample period
52 times and negative 65 times. Of those 117 times, the and for all three sub-periods; for daily as well as weekly
GSCI return deviated from its mean by more than one returns; for positive as well as for negative exceptional
standard deviation a total of 32 times, 13 times below the returns; and for periods of stock market upturns, as well
mean but 19 times above the mean. In other words, when as for downturns.

Extreme Correlation Analysis the two series. We define correlation at an exceedance
level q as the correlation between the two series when
To further investigate possible links between both of them exceed the predefined threshold level of
equity and commodity investments in periods of market q. We choose the empirical distribution of each series to
stress, we compute the exceedance correlation between determine threshold levels. This construction allows us
Exhibit 15
Extreme-Event Cross-Correlations, 1991–2008
Notes: This exhibit plots, for each percentile of the joint return distribution, the cross-correlation between the weekly returns on unlevered passive equity and
commodity investments (solid lines, left-hand scales) and the number of observations in each percentile (dotted line, right-hand scale).

to calculate the cross-correlation between the weekly We identify substantial variations over time in the
returns on unlevered passive equity and commodity potential diversification benefits that commodities could
investments for each percentile of the joint return dis- bring to equity investors. In particular, visual inspec-
tribution. This technique is similar to that used by tion suggests that equity–commodity co-movements
Longin and Solnik [2001] to assess pairwise U.S.— increase during periods of financial market stress. We
international equity market linkages during periods of are investigating possible explanations for these f luctua-
extreme returns. tions, including time-varying commodity fundamentals,
Exhibit 15 summarizes our results. Of particular common shocks to liquidity in financial markets, and
interest is, naturally, what happens when both equity commodity market participation by financial traders.
and commodity returns are either very high or very low.

In Panel A, estimated from 1991 to May 2008, we find Endnotes
weak extreme-event correlations (the absolute cross-
correlation value is less than 0.1 for the vast majority We thank Celso Brunetti, Francesca Carrieri, Vihang
of returns). Interestingly, conditional on both equity Errunza, Pat Fishe, Andrei Kirilenko, Delphine Lautier,
and commodity returns being in the bottom quartile, Joëlle Miffre, Jim Moser, David Reiffen, Andy Smith,
the two returns series are negatively correlated. In con- Kirsten Soneson, an anonymous referee, and participants at
the EFMA 2008 Symposium on Risk and Asset Management
trast, Longin and Solnik found high positive correlations
in Nice, the Annual EFMA Meeting in Athens, and a CFTC
across international equity markets in down markets.
workshop for helpful comments. This article was started when
Thus, Panel A highlights another aspect of the diversi- Büyükşahin and Robe were with the CFTC. The analyses
fication benefits that commodities provided to equity were carried out and subsequent drafts were written when
investors between 1991 and May 2008. Robe was a consultant to the U.S. Securities and Exchange
The picture changes if we include the second half Commission (SEC). The CFTC and the SEC, as a matter
of 2008. Panel B of Exhibit 15 (which uses the full of policy, disclaim responsibility for any private publication
sample through November 2008) shows that the cor- or statement by any of their employees or consultants. The
relation is always positive and exceeds 0.3 for returns in views expressed herein are those of the authors and do not
the top and bottom quartiles of the joint distribution. necessarily ref lect the views of the SEC, the CFTC, or other
From a portfolio diversification perspective the finding staff of either Commission.
that, conditional on equity and commodity returns both
1
See, e.g., Ankrim and Hensel [1993], Froot [1995],
Huberman [1995], Satyanarayan and Varangis [1996] and
being poor, the two return series are positively cor-
Greer [2001] for early work on how commodities help reduce
related suggests that the “commodity umbrella” leaks
an investor’s unconditional portfolio risk. See Erb and Harvey
when it “rains” heavily. [2006], Gorton and Rouwenhorst [2006], and Miffre and
Rallis [2007] for evidence on the strategic and tactical values
ConclusionS of commodity investments. Datasets in these newer papers
end in 2004.
Amid sharp rises in both commodity prices and 2
Whereas we find no increase in cross-market linkages,
commodity investing, many commentators have won- Büyükşahin et al. [2008] find closer intra-market linkages;
dered whether commodities nowadays move in sync since 2003, greater market participation by commodity index
with equities. We provide evidence that challenges this funds, hedge funds, and other financial insitutions helped to
idea. Using dynamic correlation and recursive cointe- more closely link the prices of different-maturity crude oil
gration techniques, we find no persistent increase futures.
in co-movements between the returns on passive
3
We measure the percentage rate of return on the Ith
investable index in period t as r It = 100 Log(PIt /PIt-1), where PIt
commodity and equity investments over the course of
is the value of index I at time t. We measure the volatility of
the last 17 years.
an index in period t as (r It – ¯a) 2, where ¯a is the mean value of
Our findings are consistent with the notion that r It over the relevant sample (sub-)period.
commodities can often provide benefits in terms of port- 4
We use equity returns exclusive of dividend yields.
folio diversification. This conclusion is tempered, how- While this approach underestimates expected returns on
ever, by our finding that those benefits did not materialize equity investments (Shoven and Sialm [2000]), the correlation
when diversification would have helped the most. estimates that are the focus of our article should be essentially

unaffected insofar as large U.S. corporations smooth dividend Carrieri, F., V. Errunza, and K. Hogan. “Characterizing World
payments over time. Market Integration through Time.” Journal of Financial and
5
Exhibits presenting the corresponding statistics for Quantitative Analysis, Vol. 42, No. 4 (2007), pp. 915–940.
daily and monthly returns, as well as for weekly returns in
each of our three successive sub-periods, are available upon Chong, J., and J. Miffre. “Conditional Correlation and Vola-
request. tility in Commodity Futures and Traditional Asset Markets.”
6
At the monthly frequency, the GSCI’s correlation with Journal of Alternative Investments, forthcoming 2009.
the S&P 500 and the DJIA was positive in 1992–1997 (0.27,
significant at the 5% level) but statistically significantly nega- de Roon, F.A., T.E. Nijman, and C. Veld. “Hedging Pressure
tive in 2002–2007 (–0.25 with the DJIA and –0.3 with the Effects in Futures Markets.” Journal of Finance, Vol. 55, No. 3
S&P 500). (2000), pp. 1437–1456.

7
Plots using the DJIA instead of the S&P 500 are sim-
ilar, as are plots using two other estimation methods than Engle, R. “Dynamic Conditional Correlation: A Simple
DCC (rolling historical correlation; exponential smoother Class of Multivariate Generalized Autoregressive Conditional
with 0.94 smoothing parameter). Heteroskedasticity Models.” Journal of Business and Economic
8
Chong and Miffre [2009] discuss diversification strate- Statistics, Vol. 20, No. 3 (2002), pp. 339–350.
gies based on individual commodity futures.
9
Using three years (rather than one) for the initial esti- Erb, C.B., and C.R. Harvey. “The Strategic and Tactical
mation does not qualitatively change the results. Value of Commodity Futures.” Financial Analysts Journal,
10
Formally, we re-scale the trace statistics by the 95% Vol. 62, No. 2 (2006), pp. 69–97.
quantile of the trace distribution derived for the selected
model without exogenous variables or dummies ( Johansen Fama, E.F. “Stock Returns, Real Activity, Inf lation, and
and Juselius [1992]). Money.” American Economic Review, Vol. 71, No. 4 (1981),
pp. 545–565.
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Commodities and Equities:

Ever a “Market of One”?

76 Commodities and Equities: Ever a “M arket of One”? Winter 2010

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ment took place. An exception is a contemporaneous

Here, we first identify the days and weeks during

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Returns on Equity and Commodity Indices

Exhibit 1 presents some descriptive statistics for the

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• Between January 1991 and November 2008, the

trounced commodity returns in 1992–1997, but

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The evidence regarding volatility correlations

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rankings vary significantly from period to period. Indus-

Exhibit 6 shows the simple correlations between

• Equity returns exhibit statistically significantly

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components, hinting at a common economic vari- Short-Term Co-Movements

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recursive method, however, allows us to see the

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GSCI. Implicit in this approach is the notion that, if

changes in extreme linkages have taken place because of

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and commodity returns are either very high or very low.

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S&P 500). (2000), pp. 1437–1456.

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Kilian, L. “Not All Oil Price Shocks Are Alike: Disentangling

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