Emerging Markets Finance & Trade, 52:1698–1723, 2016

Copyright © Taylor & Francis Group, LLC
ISSN: 1540-496X print/1558-0938 online
DOI: 10.1080/1540496X.2016.1143248

Modeling Time-Varying Correlations in Volatility Between
BRICS and Commodity Markets
Sang Hoon Kang1, Ron McIver2, and Seong-Min Yoon3
1
Department of Business Administration, Pusan National University, Busan, Republic of Korea;
2
Centre for Applied Financial Studies (CAFS), School of Commerce, UniSA Business School,
University of South Australia, Adelaide, SA, Australia; 3Department of Economics, Pusan National
University, Busan, Republic of Korea

ABSTRACT: This article investigates the asymmetric and long memory volatility properties and dynamic
conditional correlations (DCCs) between Brazilian, Russian, Indian, Chinese, and South African (BRICS)
stock markets and commodity (gold and oil) futures markets, using the trivariate DCC-fractionally inte-
grated asymmetric power autoregressive conditional heteroskedasticity (FIAPARCH) model. We identify
significant asymmetric and long memory volatility properties and DCCs for pairs of BRICS stock and
commodity markets, and variability in DCCs and Markov Switching regimes during economic and financial
crises. Finally, we analyze optimal portfolio weights and time-varying hedge ratios, demonstrating the
importance of overweighting optimal portfolios between BRICS stock and commodity assets.
KEY WORDS: BRICS stock markets, volatility, structural breaks, time-varying hedge ratios, multivariate
DCC-FIAPARCH model

Introduction
As financial integration across countries and assets increases, the financialization of commodity
markets has become an important ingredient for investors seeking to diversify their investment
portfolios. Interestingly, the financialization of commodities encourages investors to choose com-
modities as a hedge or safe haven, especially when returns on the commodity are negatively
correlated with stock returns during periods of financial turmoil (Hood and Malik 2013;
Silvennoinen and Thorp 2013).
Understanding investment opportunities in commodities requires appropriate modeling of time-
varying correlations between commodity and equity markets. A good understanding of these correla-
tions is an essential component of designing strategies for optimal asset allocation, portfolio optimiza-
tion, risk management, and hedging. Investment in commodities that have a zero or negative
correlation of returns with those of equity assets should provide better diversification outcomes than
a portfolio without commodities (Sadorsky 2014). Thus, a mixed commodity-stock portfolio may offer
more expected return and lower risk than a stock only portfolio.
Existing literature presents studies on the linkage between developed stock markets and commodity
markets (mostly oil or gold) and across commodity markets. Gold can act as a hedge asset in tranquil
periods and a safe haven during periods of turmoil, as seen in the empirical studies of Baur and Lucey
(2010), Baur and McDermott (2010), Ciner, Gurdgiev, and Lucey (2013), Hood and Malik (2013), and
Reboredo (2013).
The growing importance of the emerging markets in global portfolio allocation calls for further
research into volatility spillovers between the Brazil, Russia, India, China, and South Africa (there-
after BRICS) and commodity markets (gold and oil). Given their economic prospects relative to

Address correspondence to Seong-Min Yoon, Professor, Department of Economics, Pusan National University,
Busan 609-735, Republic of Korea. E-mail: smyoon@pusan.ac.kr
Color versions of one or more of the figures in the article can be found online at www.tandfonline.com/MREE.

MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1699

other emerging market and developed country economies, the BRICS have attracted a great deal of
attention from national and international investors, portfolio managers, and policymakers
(Hammoudeh et al. 2013). The BRICS nations currently represent some of the top emerging
economies in the world, representing 40 percent of the world’s population and 20 percent of the
world’s gross domestic product (GDP).
The BRICS alliance is based on growth revolving around their tangible assets of gold and energy,
playing a crucial role as major producers and consumers in commodity markets. For example, China
represents the world’s largest producer of gold, as well as the second largest gold consumer, followed by
India. Russia is both the fourth largest producer of gold and the fourth largest market for gold jewellery.1
According to a report by the Energy Information Administration (EIA), China is the world’s second
largest consumer of oil and projected to move from second largest net importer of oil to largest, while
India was the fourth largest oil importer in 2014. Russia, one of the world’s energy superpowers, exports
70 percent of the oil it produces, and its real GDP is surpassing average growth rates in all other G8
countries.2 Therefore, an assessment of the volatility linkage between the BRICS stock and commodity
markets is crucial for making optimal investment decisions, as well as being critical knowledge for
policymakers needing to implement policies to control exposure to market risk.
This study examines the issue of volatility spillover effects between the BRICS stock and
commodity futures markets, while accommodating the effects of asymmetric and long memory
volatility properties. It makes several major contributions to the existing literature. First, it examines
the dynamic conditional correlation (DCC) between BRICS stock markets and the commodity futures
markets. Recent literature has revealed the volatility linkage between stock and commodity assets
(gold and oil). However, there was no clear cut conclusion, and little attention was paid to the
relationship between BRICS stock indices and commodity assets.
Second, the bivariate DCC model is a very popular approach for measuring the dynamic correlation
of stock-commodity portfolios. However, this approach is limited to estimation within diverse
portfolios. In this context, this study implements a trivariate DCC model in measuring the dynamic
correlation of triple combinations (i.e., BRICS stock-Gold-Oil). This approach provides more accurate
dynamic correlations for stock-commodity portfolios with which investors may calculate optimal
weights and hedge ratios.
Third, the study explicitly takes into account long memory and asymmetry using the trivariate
dynamic conditional correlation fractionally integrated asymmetric power autoregressive conditional
heteroskedasticity (DCC-FIAPARCH) model. The FIAPARCH model offers the flexibility to model
the conditional second moment, taking into account the long memory property, the predictability
structure of the return volatility, and the asymmetric characteristics of the volatility (i.e., leverage
effects). The DCC modeling captures the conditional time-varying correlations among the sample
markets with respect to market conditions. Of interest is the investigation of the volatility spillover
effects that account for long memory and asymmetry in the volatility linkage between BRICS and
commodity markets.
Fourth, this study analyzes the impact of economic turbulence and financial crises on the dynamic
conditional correlation between BRICS stock prices and commodity prices. To identify the crisis
period and its regimes, we estimate excess volatility phases using a Markov switching dynamic
regression (MS-DR) model and consider official phases of the global financial crisis (GFC) and the
European sovereign debt crisis (ESDC). It is essential to provide more accurate details on conditional
correlation shift behaviour around economic events and financial crises.
Finally, this study further examines optimal portfolio design and hedge ratios using the estimated
conditional covariances between the BRICS stock and commodity markets. From a portfolio manage-
ment perspective, accurate estimation of the time-varying covariance matrix is required to develop
financial and strategic decisions regarding accurate asset pricing, risk management, and portfolio
allocation. Our findings on optimal weights and hedge ratios indicate that investors can make
appropriate capital budgeting decisions and effectively manage the exposure to portfolio risks in the
BRICS stock prices.

. copper. and Technology) and find evidence of signifi- cant volatility spillover between the oil and sector stock markets. Chkili. They identify that the commodities demonstrate different volatility persistence responses to financial and geopolitical crises. using a bivariate exponential (EGARCH) model. The final section presents concluding remarks. Engle. the empirical findings suggest that the stock prices of clean energy companies have experienced more impact from technology stock prices than oil prices. The fourth section provides the descriptive statistics of the sample data and the fifth section discusses the empirical results. and Nguyen (2014) use the DCC-FIAPARCH model to examine the time-varying properties of long memory and asymmetry in the volatility of crude oil prices (WTI and Brent) and the S&P 500 index. Health. They present strong evidence of significant volatility transmission between the S&P 500 index and commodity markets. KANG ET AL. portfolio design.) sector indices (Financials. multi- variate DCC. and silver) and the Standard and Poor’s (S&P) 500 index. The next section reviews the conditional correlation between stock markets and commodity markets as discussed in the literature. Brief Literature Review A number of studies provide evidence of significant links between stock and commodity (mostly oil or gold) markets. dynamic volatility spillovers between oil and stock markets are of increasing interest in the construction of optimal risky portfolios and hedge ratios in financial risk management. Bhar and Nikolova (2009) examine the dynamic correlation between oil prices and the stock market in Russia. employing the VAR-CCC-GARCH model. Kraft and Kroner (BEKK). Sadorsky (2014) investigates the volatility asymmetry and correlation between emerging market stock prices. with stock investments contributing more to a reduction in portfolio risk than crude oil investments. In addition. oil. while the S&P 500 index responds to both financial and geopolitical crises. They find strong evidence of long memory and asymmetry in the volatility of oil and stock markets. and DCC models. CCC. Following that. The remainder of this article is organized as follows. and Nguyen (2011) examine the extent of volatility transmission. food.S. They find that three geopolitical “shocks”—the 2001 September 11 terrorist attack. as well as their dynamic correlations over the 1998–2013 period. Malik and Hammoudeh (2007) find that the volatility of Gulf equity markets is affected by the volatility of oil markets. their dynamic correlations are affected by several economic and geopolitical events. Sadorsky (2014) suggests that an increase in correlations . Sadorsky (2012) analyzes the volatility spillovers between oil prices and the stock prices of clean energy companies and technology companies using a variety of multivariate GARCH models. Given recent uncertainties in oil prices. Arouri. H. and constant conditional correlation (CCC) models. the 2003 war in Iraq. copper. West Texas Intermediate (WTI) oil.e. They find that the VAR-GARCH model provides better diversification benefits and hedging effectiveness. Industrials. gold. and wheat. Surprisingly. including the Baba. Aloui. Jouini. Mensi et al. and bev- erages) over the turbulent 2000–11 period. but only in the case of Saudi Arabia is there evidence of a significant volatility spillover from the equity market to oil markets. and the 2006 civil war in Iraq—caused correlations to become negative. Malik and Ewing (2009) focus on the volatility spillover between oil prices and the United States of America (U. and hedging effectiveness in oil and sector stock returns in Europe and the United States using the vector autoregression generalized ARCH (VAR-GARCH). Consumer. Some studies have investigated the dynamic links between the emerging stock and commodity markets. the third sectionexplains the econometric methodologies utilised in this study. gold. Furthermore. Brent oil. (2013) investigate the return links and volatility transmission between the S&P 500 and commodity price indices (energy. Using the vector autoregressive moving average asymmetric (VARMA-AGARCH) and DCC-AGARCH models Sadorsky (2014) finds that emerging stock prices and oil prices exhibit volatility asymmetry.1700 S. Choi and Hammoudeh (2010) show two possible volatility regimes for strategic commodity prices (i.

who combines the FIGARCH formulation of Baillie. economic policy uncertainty has no impact on the BRICS stock markets. δ=2 where ht raises the i i th standard deviation to the power of δi . and Mikkelsen (1996) with the APARCH model of Ding. as well as changes in U. we fit a univariate pffiffiffiffi FIAPARCH model to each set of sample returns. ST ð0:1:vÞÞ . and Mikkelsen 1996). Similarly. However. Mensi et al. 1Þ .S. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1701 between these assets after 2008 led to reduced diversification benefits. and hedge effectiveness within these markets. (2014).4 The AR (1) model is defined as follows: pffiffiffiffiffi r1 ¼ μ þ ψrt1 þ εt . ht : We assume that the return-generating process is described by an autoregressive (AR) model in which the dynamics of current sample returns are explained by their lagged returns. jβj < 1 . The AR (1) term captures the speed with which market information is reflected in the time series. Bollerslev.S. the structure of the conditional variance of FIAPARCH model is specified as in Tse (1998). it is apparent that previous empirical studies investigating volatility transmission across stock markets and commodity markets have offered a mix of conclusions. (2014) examine the dependence structure between commodities and Chinese stock markets using copula functions. (1) where jμj 2 ½0. whereas U. respectively. Overall. Furthermore. jφj < 1 . Bollerslev. They emphasize that this dependence structure is often asymmetric and affected by the onset of the recent GFC.3 The model is designed to allow for two-stage estimation of the conditional covariance matrix. (2014) use a quantile regression approach to investigate the dependence between the BRICS stock markets and global factors in the form of the S&P index. Next. oil and gold. implying that commodity futures play an important role in portfolio diversification benefits and risk reduction for investments in the Chinese stock market. Granger. and Engle (1993). as represented by the Chicago Board Options Exchange Volatility Index. with the exception of Hammoudeh et al. this study overcomes this limitation by using the trivariate DCC-FIAPARCH model to investigate the time-varying volatility properties and DCCs among the BRICS and commodity markets during the turbulent period of 1997–2013. 1Þ . hedge ratios.5 and ht is positive with probability one. and the long memory parameter d (0  d  1 ) captures long memory in the conditional volatility. convergence of emerging market stock returns. The FIAPARCH ð1.6 δ ðδ > 0Þ which takes finite positive values. In the first stage. d. ð1  LÞd is the fractional differencing operator expressed in terms of a hypergeometric function (Baillie. Thus. With ε1 ¼ zt ht . Hammoudeh et al. is the power term of returns for the predictable component in volatility persistence. the innovations {Zt} follow the Student-t distribution ðzt . The asymmetry parameter λ > 0 indicates that negative shocks give rise to higher volatility than positive shocks of equal size (Tse . we estimate dynamic correlations to better calculate optimal weights. They provide strong evidence of low and positive correlations between these markets. then obtain estimates of conditional variance. This reflects differing empirical methods and datasets. these studies have not utilized methodologies that can control for multivariate dynamic correlations. and that the cheapest and most expensive hedges were long oil and copper. 1Þ model is given by: δ=2 ht ¼ ω½1  βðLÞ1 þ ½1  ½1  βðLÞ1 ϕðLÞð1  LÞd ðjεt j  λεt Þδ : (2) Here ω 2 ð0. Empirical Methodology We estimate a multivariate AR(1)-DCC-FIAPARCH model to measure the dynamic correlation between the BRICS stock markets and commodity markets. More recently. market uncertainty. jψ j < 1 .

given by: Rt ¼ ðdiagðQt ÞÞ1=2 Qt ðdiagðQt ÞÞ1=2 . (4) That is " # " p1ffiffiffiffiffi # p1ffiffiffiffiffi 0 0 q11 q11 q12 q11 Rt ¼ : 0 p1ffiffiffiffiffi q21 q22 0 p1ffiffiffiffiffi q 22 q 22   pffiffiffiffiffiffiffi The covariance matrix Qt ¼ qii.t1 ρij.t . the variance-covariance matrix ðH t Þ of residuals is defined as follows: Ht ¼ Dt Rt Dt .1702 S.t .and its own lagged value according to Equation (5) as: unconditional variance-covariance matrixðQÞ  þ adcc ðut1 u0 Þ þ βdcc Qt1 : Qt ¼ ð1  αdcc  βdcc ÞQ (5) t1 The coefficients αdcc and βdcc are nonnegative scalars satisfying the condition that αdcc þ βdcc < 1 pffiffiffiffiffiffiffiffi pffiffiffiffiffiffiffiffiffiffi (Engle 2002). the FIAPARCH model reduces to the FIGARCH model which includes a fractionally integrated process in conditional variances. 1Þ . we transform the return series using their estimated standard deviation. the estimate of the DCC model is done using a two-step maximum likelihood estimation method in which the log-likelihood is expressed as: .10 If the estimated ρij. . Note that.t ¼ rffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi h iffirffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi h iffi ð1  αdcc  βdcc Þ qii þ αdcc u2i. Parameterization of the FIAPARCH-DCC model allows direct inference of the time-varying correlations between BRICS. j ¼ 1. (3)   1=2 1=2 where Dt ¼ diag h11. For example.t = hii. .t is defined as the conditional variance obtained from the AR (1)-FIAPARCHð1.t is a diagonal matrix containing the square root of the ith diagonal elements of Qt . and deals with a relatively large number of variables in the system without having a numerical convergence problem at the estimation stage.t1 þ βdcc qij. 1= qNN . KANG ET AL. .9 ½diag ðQt Þ1=2 ¼ 1= q11. allowing investigation of the time-varying correlations while ensuring positive definiteness in the variance-covariance matrix ðH t Þ under simple conditions imposed on specific parameters.t depends on the standardized residuals ui.t . The structure of conditional correlations is modeled using the DCC approach of Engle (2002).t1 þ βdcc qjj. hii. . . .t . following Engle (2002). The dynamic correlation is expressed as: ð1  αdcc  βdcc Þ qij þ αdcc ui. In the multivariate case that we use. when γ ¼ 0 and δ ¼ 2 .t1 þ βdcc qii.t1 ð1  αdcc  βdcc Þqjj þ αdcc u2j. .t ¼ εi. .8 In the second stage. hNN . ρij. and use this transformed data to estimate the parameters of the conditional correlation. H. gold and oil price returns. 3 and iÞj (6) Significance of αdcc and βdcc implies that the estimates obtained from the DCC-FIAPARCH model are dynamic and time-varying.t1 uj. d. Rt is a matrix of time-varying conditional correlations. 1998). the variance process in Equation (2) reduced to the APARCH model. . the  . Furthermore. . if d ¼ 0 .t is positive. the correlation between return series is positive and vice versa (Engle 2002). . 2.7 The FIAPARCH model increases the flexibility of the conditional variance specification by allowing an asymmetric response of volatility to positive and negative shocks and long memory volatility dependence.t1 : i.t indicates the direction and strength of correlation.

In early 2009. BRICS stock prices were extracted from the Morgan Stanley Capital Index (MSCI) database (www. given the estimated parameters in the first stage. The Russian stock market depends on foreign capital and is subject to high geopolitical risk. followed by the Russian stock market. ϕÞ ¼  n logð2π Þ þ log jDt j þ εt Dt εt þ logjRt j þ ut Rt ut  ut ut : (7) 2 t¼1 t¼1 θ and ϕ are the parameters in Dt and Rt .t1 Þ.S. the price trend suffered reversal due to the onset of the Eurozone sovereign debt crisis (ESDC) during early 2010–12. the gold price increased almost continuously during the GFC and ESDC periods.t ¼ lnðPi. 2013. as well as for two commodity futures prices. the global markets experienced macroeconomic deterioration.t =Pi. respectively.. all indices are denominated in USD in order to have comparability. we observe a similar trend for all BRICS stock and oil futures markets. The time period chosen for this study spans January 31. Regarding risk. gold and oil. gold presents the highest average returns. because investors perceived a higher risk to most investments and. expressed in USD per Troy ounce. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1703 " # T   X T   1 X 2 0 2 0 1 0 lt ðθ. Figure 1 displays the dynamics of the daily BRICS and commodity futures indices over the sample period. is traded on the New York Mercantile Exchange (NYMEX). are traded on the Commodity Exchange (COMEX) in New York. instead. which are expressed in U.. the correlation component of the likelihood function (the second part of Equation (7)) is maximized in order to estimate correlation coefficients.t denotes the continuously compounded rate of return for index i at time t. Following Bekaert and Harvey (1995). purchased perceived safer invest- ments such as gold. The start date is dictated by the availability of data on individual MSCI indices and commodity futures. then a phase of stabilization. where Ri. suggesting that investment in the Russian stock market may prove to be . Closing oil prices. were extracted from the EIA database.e. The log-likelihood function is maximized by using a two-stage approach.12 Data and Preliminary Analysis Data This study considers the daily closing spot price index series for the BRICS stock market indices. At the first stage. Unlike the trend price for oil. the Russian stock market showed the highest value of standard deviation (volatility). dollars (USD) per barrel. and to allow for a better understanding of the volatility correlation patterns between the BRICS stock markets and commodity futures markets. and Pi. Ri. The WTI futures crude oil benchmark.com). the log-likelihood function is maximized over the Dt parameters in the first part of Equation (7).14 Preliminary Analysis We calculate continuously compounded daily returns by taking the difference in the logarithms of two consecutive prices: i. The sample period is chosen to be sufficiently recent and extended enough to account for regional and international economic events. 2000 to October 14. Gold futures prices. and tentative signs of recovery in late 2009. As illustrated in these figures. which corresponds to the global financial crisis (GFC). Table 1 presents the descriptive statistics of the daily return series for the BRICS stock markets and the commodity markets.t denotes the price level of index i at time t. the reference crude oil for the United States. a flight-to-quality phenomenon. In Panel A.msci. avoid the effects of local inflation and national currency fluctuations on the indices.11 At the second stage. a sharp decrease from early 2007 to summer 2008. as offered by the Thomson Reuters Datastream. After that.13 We use daily data to capture the speed and intensity of the dynamic spillovers between commodity futures and emerging equity markets.

In light of the J-B test results. with Russia having the highest. Excess kurtosis values for all return series are greater than three. Regarding nonnormality. implying that gold provides higher returns with lower risk. This implies frequent small gains and extremely large losses. all return series display negative skewness.1704 S.. with returns on the Russian stock market being the most skewed. more risky than for other BRICS markets. Conversely. signaling a nonlinear process. All statistics . The Jarque-Bera (J-B) test results support the presence of deviations from the Gaussian distribution.e. H. Dynamics of BRICS and commodity indices. indicating the presence of peaked distributions and fat tails (i. we test whether the skewness and kurtosis of the variables correspond to that of a normal distribution using the D’Agostino (1970) normality test. Figure 1. gold returns have the lowest volatility. KANG ET AL. all return series display leptokurtosis).

9*** 4249. and conditional homoscedasticity at the 1 percent significance level.1654 Std.664*** 25.17*** −1077. −0. 1705 . Africa refers to the Republic of South Africa.49*** 53.00031 0. 0.684*** −56. and the Ljung-Box test for autocorrelation. Africa Gold Oil Panel A: Descriptive statistics Mean 0.322*** −57.8*** 1180.145*** PP −53.1455 0.1762*** Kurtosis 9. J-B and Qð30Þ refer to the empirical statistics of the Jarque-Bera test for normality. PP.673*** 49.9191*** 14.3*** 1950. Descriptive statistics and unit root tests of daily returns of BRICS and commodity prices Brazil Russia India China S.8*** 3637.0120 0.3945*** 7.101*** 9.0184 0.420*** −34.00029 0. *** denotes rejection of the null hypotheses of normality.4706*** −0.879*** 45.3774*** 7.2397 0. unit root.1717 −0. (1992) stationarity test.161*** −34.0194 0.65*** 2703.1504 0.1948 0.361*** −35.1197 0. respectively.0862 0.0*** ARCH(10) 156.3159*** −0.5*** 5866.721*** Q2 ð30Þ 5700. dev.94*** 61.4847*** D’Agostino 2115.0981 −0.1565 Min.1832 −0.4988*** 8. nonstationarity. The ARCH(10) test of Engle (1982) checks the presence of ARCH effects.8*** 1452.103*** 11.523*** 789.874*** −33.665*** −55.0226 0.0637 0.1404 0.413*** 85.00026 0.3015*** −0.00040 0. 0.1595 −0.2559 −0.354*** 67.4*** 2977.1661 0.2*** 2561.0256 0.9*** 3389.00044 0.1109 0.4*** 1105.634*** 17.1185*** −0.0187 0.856*** −55. no autocorrelation.9*** Qð30Þ 155.3*** 674.5*** KPSS 0.2*** 2914.0241 Skewness −0.797*** 80.30*** 120.67*** 2607. and KPSS are the empirical statistics of the Augmented Dickey and Fuller (1979).1235 0.868*** −34.132*** −33.1356 −0.053*** Panel B: Unit root tests ADF −42.1 *** 17884*** 9506. and the Kwiatkowski et al.93*** 109.2400*** −0.2*** 3955.0343 Notes: S. ADF.0*** 805.782*** 53. D’Agostino (1970) normality test is based on x2 statistic. the Phillips and Perron (1988) unit root tests.1*** J-B 6929.1453 0.00019 0.3297*** −0.00037 Max. Table 1. respectively.

supporting that use of the FIAPARCH specification is appropriate. Phillips. the AR (1) parameters of the commodity futures (gold and oil) are negative and insignificant. a negative correlation between returns and volatility). we strongly reject the null of no ARCH effects at the conventional levels in all cases. confirming the nonnormality characteristics for all return series. and the Kwiatkowski. For the gold futures market. indicating that past information is instantaneously and rapidly embodied in the current stock prices. KANG ET AL. However. Apart from the combination of Russia-gold-oil. Kenourgios. the use of a GARCH-based approach is appropriate for modeling stylized characteristics such as fat-tails. The gold futures return shows the highest value for the long memory volatility process when comparing the degree of the long memory parameter ðdÞ: This finding is consistent with the prior studies of Arouri et al. More importantly. in all cases except gold. process). the fractional integration coefficients ðdÞ are significant at the l percent level. Leverage effect coefficients ðλÞ are positive and statistically significant at the 1 percent level. and Shin (KPSS) test. and Nguyen (2014).e. Schmidt. These features support the use of the Student-t distribution in the estimation process. from the D’Agostino (1970) normality test reject the null hypothesis. both the ARCH effect (αdcc ) and GARCH effect (βdcc ) are positive and significant in all cases. Panel B in Tables 2–6 presents the estimates of the DCC model.15 In Panel A of the Tables. the average correlation is significant and positive between the BRICS stocks and the two commodity combinations. indicating an asymmetric response of volatilities to positive and negative shocks of the same magnitude. and Simos (2013).. and Chkili. an i.e. Finally. persistence and long memory for the stock and commodity returns. contradicting the hypothesis of leverage effects (i. the coefficients of . indicating that the DCC model provides a good fit in all cases (Engle 2002. Interestingly. Dimitriou and Kenourgios 2013. implying that past commodity futures prices are negatively correlated or are uncorrelated with current prices. Thus. 2014. H. 1Þ model between the BRICS stock markets and the two commodity futures markets. Therefore. Dimitriou..1706 S. suggesting that all volatility processes are persistent over time. The significance of the power term ðδÞ leads to rejection of the null hypothesis of δ ¼ 2 in all cases. Empirical Results and Financial Implications Empirical Results This section examines the volatility properties and evaluates the time-varying conditional correla- tion between BRICS stock prices and commodity prices. the AR (1) parameter is positive and statistically significant at the 1 percent level for all BRICS stocks. By applying the ARCH test of Engle (1982). Mensi et al. supporting rejection of the null hypothesis of a unit root. Aloui. The Brazilian stock market has the highest average conditional correlation with oil. the nonparametric Phillips-Perron (PP) test. only Russia is an oil-exporting country. d.d. Tables 2–6 report the estimation results under the Student-t distributed innovations of the trivariate DCC-FIAPARCH ð1. the Russian stock market is uncorrelated with either the gold or oil markets as. the coefficient is insignificant. the KPSS test statistic does not reject the null hypothesis of stationarity at the 1 percent level of significance. Panel B of Table 1 provides the results of three types of unit root test: the standard parametric augmented Dickey-Fuller (ADF) test. The values resulting from the ADF and PP tests are large and negative.i. while the South African stock market reveals the strongest correlation with gold. (2012). all return series are stationary processes. clustering volatility. among the group.16 The sum of these parameters (αdcc +βdcc ) in each model is less than unity. In addition. results of the Ljung-Box test of the return residuals ðQð30ÞÞ and the squared residuals ðQ2 ð30ÞÞ fail to support the null hypothesis of a white noise process (i. Sadorsky 2014). Additionally. supporting that conditional pairwise correlations are mean reverting.

16305*** (0.06949 0.10835) (0.06699) APARCH (λ ) 0.70284*** 0.97969*** (0.21041*** (0.1) model Const.13143) (0. **.05049) ARCH 0.01753) (0.00352) (0.61437*** −0.65892*** (0.03810) (0. ðωÞ 0. except for the case of Russia.35778*** (0.01606*** (0.85 [0.04184** (0.46667*** 0.18443) d-FIGARCH 0. Q2 ð30Þ is the empirical statistics of the Ljung-Box test applied to squared standardized residuals.00035) (0. Standard error values are reported in parentheses.06699) ρOilGold 0. ðμÞ and Const.09943) (0.09541) (0.d.07448) αdcc 0.00034) AR(1) 0. In addi- tion. 5 percent. at least at the 5 percent .07082) (0.93905*** 1.00460 −0.05322** 0.0229) (0. the Ljung-Box Q2 ð30Þ test statistics for the squared standardized residuals does not support rejection of the null hypothesis of no serial correlation.25644*** (0. the Hosking (1980) and McLeod and Li (1983) test results suggest acceptance of the null hypothesis of no serial correlation in the DCC models.00320 0.746 [0.12503* (0.00001 0.592 [0.00018) (0.09269) (0. and *** indicate the significance at the 10 percent. Hosking (1980) and McLeod and Li (1983) multivariate Portmanteau statistics did not reject the null hypothesis of no serial correlation (using thirty lags).51307) Panel C: Diagnostic tests Q2 ð30Þ 21. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1707 Table 2. confirming that the trivariate DCC-FIAPARCH model based on the Student-t distribution is appropriate.9002] 25. providing evidence of no misspecification in the univariate FIAPARCH model.8710] 20.65014*** (0.7900] Notes: Const.10237) (0. and 1 percent levels.01816) (0. ðμÞ 0.517 [0.00048*** 0.6880] Hosking2 (30) 248. respectively.13530 0. *. According to the diagnostic tests (Panel C of Tables 2–6). Empirical results for Brazil-Gold-Oil Brazil Gold Oil Panel A: Estimates of AR (1)-FIAPARCH (1.30605*** 0.00681) Student-t df 8.18019) Panel B: Estimates of the DCC model ρGoldBrazil 0.01942) Const.18928*** (0.43162*** 1.39438*** (0.10673) (0.23009) APARCH (δ ) 1.11376*** −0.06016) GARCH 0. ðωÞ are the constants of the mean and variance processes.00057 (0. P-values are in brackets.25642 (0.7934] McLeod-Li2 (30) 249. the Student-t density function (df) are significantly positive and > 2. respectively.12 [0.07554) ρOilBrazil 0.37547*** 0.00434) βdcc 0.13519) (0.29840*** 0.

17 [0.29840*** (0.46376*** 0.613 [0. instead varying greatly with time in all pairwise comparisons.04023 (0. Table 3.09358 (0.12182) ρOilRussia −0. significance level. KANG ET AL. It is also important to compute the .07299) (0.23009) APARCH (δ ) 1.18019) Panel B: Estimates of the DCC model ρGoldRussia −0.10836) ρOilGold 0.00057 (0.35778*** (0. the DCCs reveal that investors have adjusted their portfolio structure accordingly.10835) (0. and so there was no evidence of statistical misspecification in the trivariate DCC- FIAPARCH models.87691*** (0. Figures 2 and 3 present the conditional correlation obtained with the trivariate-DCC-FIAPARCH model for January 2000 to October 2013.18928*** (0.00352) (0.27554*** −0.18443) d-FIGARCH 0. ðμÞ 0.11102) αdcc 0. All BRICS-oil pairwise comparisons (Figure 3) evidence a slightly upward trend or positive correlation after the 2007 U.00034) AR (1) 0.09943) 0. Empirical results for Russia-Gold-Oil Russia Gold WTI Panel A: Estimates of AR (1)-FIAPARCH (1.04184** (0.05049) ARCH 0.00199) Student-t df 6.03957** −0.137 [0.07099 (0.70284*** 0.19 [0.01816) (0.116 [0.93905*** 1.0685] McLeod-Li2 (30) 303.00018) (0.00320 0.65014*** (0.39438*** (0.06699) APARCH (λ ) 0.03080) (0. This indicates that there is little scope for portfolio diversification among the BRICS stock markets and oil commodity markets.46667*** 0.8104] 22.8308] 28.10237) (0. The correlation coefficients are not constant.25642 (0.00033) (0.d.0686] Note: See Table 3.01185 (0.01942) Const.04967) (0.13519) (0.00048*** 0.42638*** 0. Note that the trend of correlations indicates the benefit to be derived from diversifying and investing in the BRICS stock markets and commodity assets.5631] Hosking2 (30) 303.00052 0.65892*** (0.1708 S.36962) Panel C: Diagnostic tests Q2 ð30Þ 23.ðωÞ 0.01758) (0.00171) βdcc 0.07082) (0.11398) (0.05635 0. Indeed.06949 0.99488*** (0.1) model Const.00510*** (0. H.61434*** 1.06016) GARCH 0.00460 −0.06341) 0.08339) (0.S mortgage subprime crisis.

037 [0. who explore whether a U.03899) ρOilIndia 0.03674) αdcc 0. Yoshino.37910*** 0.08097** (0.06467) (0.39438*** (0.65014*** (0. We follow Bianconi. In order to identify excess conditional volatilityðht Þ regimes.18443) d-FIGARCH 0.00029)** (0.04184 ** (0.00048*** 0.42144*** (0.00071 0. and provide additional explanation of the factors driving the correlations between BRICS stock markets and commodity markets. we analyze further the impact of crisis events on the dynamic correlations. financial stress indicator has a significant impact on DCC estimators for stocks and bonds in the BRIC countries.03798) (0. which allows the data to .467 [0.65892*** (0.6213] 20.06099) (0.46667*** 0.70284*** 0.01988)*** (0. which are of concern to investors and portfolio managers.06949 0.18928*** (0.00460 −0.01942) Const.05489) (0.379 [0.15346) (0. The Analysis of DCC Behavior Around Regime Shifts In this section.2323] Note: See Table 3.9062] 24.01816) (0.05049) ARCH 0.1) model Const.97103*** (0.08324 −0.24851*** (0.18019) Panel B: Estimates of the DCC model ρGoldIndia 0.23009) (0.93905*** 1.43751) Panel C: Diagnostic tests Q2 ð30Þ 27.00352) (0.29840*** 0.07082) (0.7504] Hosking2 (30) 284.d.00018) (0.37 [0.01098) Student-t df 7.00320 0. and De Sousa (2013).00480) βdcc 0.ðμÞ 0.10237) (0.05535 0.45992*** 1.03870) ρOilGold 0. ðωÞ 0.S.49237*** 0.2351] McLeod-Li2 (30) 284. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1709 Table 4.00057 (0.00034) AR (1) 0.23620*** 0.06016) GARCH 0. optimal portfolio weights and the time-varying hedge ratios.14922) (0.09943) (0.13519) (0.35778*** (0.10835) APARCH (δ ) 1. Empirical results for India-Gold-Oil India Gold Oil Panel A: Estimates of AR (1)-FIAPARCH (1.08469** (0.06699) APARCH (λ ) 0.51238*** −0. we apply a Markov-switching dynamic regression (MS-DR) model.01635*** (0.59 [0.25642 (0.

we investigate further the potential shift in behavior of the DCCs between the BRICS stock markets and the two commodity markets with financial and economic events. 2009–April 22.35778*** (0.09943) (0.25642 (0.06699) APARCH (λ ) 0.48388*** 0.07066) (0.01143** (0.9380] 22.8289] Hosking2 (30) 249.10237) (0.07082) (0.11373) (0. 2000–September 27. 2010.09621*** (0.00018) (0.06016) GARCH 0. 2002) the GFC (August 1.04613*** −0.65892*** (0. respectively.226 [0.17984*** (0.39438*** (0. For this reason.04184** (0.03031) ρOilChina 0.06972) (0.1) model Const. Note that regimes zero and one indicate lower and higher values of conditional volatility. KANG ET AL.93905*** 1.59678*** 0.00460 −0.7783] Note: See Table 3.01942) Const.1710 S.2344] 19.90 [0. Table 5. ðωÞ 0.20 These regimes play a significant role in explaining the relationship between the BRICS stock markets and commodity markets.23009) (0. we broadly identify four important financial and economic events: the dot- com bubble (January 31.05247) (0.13519) (0. determine the beginning and end of each phase of the crisis.05049) ARCH 0.00034 0.01675) Student-t df 8. 2011–December 31. 2007–November 4.27304*** (0.17432*** 0.51823) Panel C: Diagnostic tests Q2 ð30Þ 35.091 [0.06949 0.17 The MS-DR model classifies the existence of two regimes: regime zero (“stable” regime) and regime one (“volatile/crisis” regime). Empirical results for China-Gold-Oil China Gold Oil Panel A: Estimates of AR (1)-FIAPARCH (1. ðμÞ 0.7796] McLeod-Li2 (30) 250.02424) (0.d.661 [0.70284*** 0.00320 0.65014*** (0.01816) (0.97521*** (0.63120*** 1.18019) Panel B: Estimates of the DCC model ρGoldChina 0.46667*** 0.01688) (0.10835) APARCH (δ ) 1. 2009 19 and the two ESDCs (November 5.00 [0.03032) αdcc 0.05489) (0.02961) ρOilGold 0.00534) βdcc 0.27567*** −0.00034) AR (1) 0.08570*** (0.00057 (0. 2011).22 We .04417* 0.00048*** 0. and May 2. H.18 As shown in Table 7.18443) d-FIGARCH 0.00027) (0.00352) (0.29840*** 0.18928*** (0.

t : (8) k¼1 c0 is a constant term.4497] McLeod-Li2 (30) 270.01942) Const.00057 (0. while j corresponds to gold or oil. Russia. and zero otherwise. and k ¼ 1 .33 [0.2593] 18. in the following mean equation: X k ρij.39885*** 1.09943) (0.04184** (0.00352) (0.22389*** (0.9493] 22.06320) (0. Empirical results for S.06699) APARCH (λ ) 0.03510) αdcc 0.00027) (0.53301*** 0.20396) (0.10835) (0. Africa Gold Oil Panel A: Estimates of AR (1)-FIAPARCH (1.880 [0.10237) (0. i corresponds to Brazil. China. generate dummies.06016) GARCH 0.01934) (0.00018) (0.05049) ARCH 0.70284*** 0.1) model Const. .25642 (0. equal to unity for the corresponding phase of events.73151*** −0. ψ are the numbers of dummy variables corresponding to the phase of events.12003) (0.01800) (0. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1711 Table 6.01816) (0.06949 0. .00603) βdcc 0.t þ ij.93905*** 1.65014*** (0. . and the first lag of the dynamic correlation ρij. and South Africa.30683*** (0.65892*** (0.t1 þ ψ k dummyk.18928*** (0.26 [0.02924*** (0.01412) Student-t df 8. India.23 In Equation (8).52299) Panel C: Diagnostic tests Q2 ð30Þ 34.07082) (0.00460 −0.04452) (0.13519) (0. ðωÞ 0.39438*** (0.30292*** 0.46667*** 0.t ¼ c0 þ φ1 ρij.00043 0.29840*** 0.27379*** (0.00320 0. ðμÞ 0.26320*** (0.03651* 0.23009) APARCH (δ ) 1.526 [0.t is put in the model to get rid of the serial correlation effect.4485] Note: See Table 3.03503) ρOilGold 0.18019) Panel B: Estimates of the DCC model ρGoldS:Africa 0.00034) AR (1) 0.06586) (0.03451) ρOilS:Africa 0.94772*** (0.35778*** (0.30224*** 0.04285** −0.8201] Hosking2 (30) 270. Africa-Gold-Oil S.d.00048*** 0.18443) d-FIGARCH 0.550 [0.

t ¼ α0 þ α1 hij. all the DCCs exhibit strong evidence of heteroskedasticity with reference to the ARCH tests. (1) In the mean equation of Panel A in Tables 8 and 9. in all cases. and Li (2007). More precisely. the coefficient ψ 1 is either negative or statistically insignificant. Additionally. conditional correlation dynamics either decreased or remained unchanged during the dot-com bubble.t : (9) k¼1 Tables 8 and 9 present the estimation results of the inclusion of dummy variables on the conditional correlation between the BRICS stock markets and the gold market. We find evidence of significant effects of the four financial and economic events. with the effects being more pronounced in the case of the variances. respectively.t1 2 þ γk dummyk. Jeon. This is based on the dummy variables’ coefficients for the mean and/or conditional variances. .1712 S. we identify impacts as follows. we use a GARCH ð1. Figure 2.t1 þ α2 ij. and the BRICS stock markets and the oil market. H. KANG ET AL. In particular. indicating that. 1Þ model to capture any structural changes as follows: X k hij.24 Following Chiang. Time-varying conditional correlation coefficients between BRICS and gold markets.

This finding can be explained by the lower economic activity during the events. (3) The coefficients of both ψ 3 and ψ 4 in the ESDC phases had either a statistically insignificant or slightly positive impact on correlations. implying a decoupling of the BRICS stock markets from the oil market during the dot-com bubble. In practical terms. (4) Regarding the variance equations in Panel B (Tables 8 and 9). the dot-com bubble had a statistically significant and negative impact on the conditional correlation between BRICS-oil pairs (Table 9). . (2) During the GFC. implying that the GFC had little impact on the correlation dynamics between the BRICS and commodity markets. Time-varying conditional correlation coefficients between BRICS and oil markets. the majority of all coefficients ðγÞ had a statistically significant and negative impact on the DCCs. supporting the hypothesis that the impact of the ESDC phases increased. relatively speaking. implying that the exogenous shifts led to a reduction in the volatility of the correlation between the BRICS stock markets and commodity markets. Implications for Risk Management and Portfolio Management Our previous findings suggest that volatility transmission across BRICS stock markets and commodity markets is a crucial element for efficient diversified portfolios and risk management. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1713 Figure 3. the majority of coefficients ψ 2 were statistically insignificant. the contagion effect between the BRICS stock markets and commodity markets.

0081*** −0.0042*** 0.0055*** (0. which allows investors to make optimal portfolio allocation decisions by con- structing dynamic risk-minimizing hedge ratios.0227 0.4353 0.0058 (0.1756 0.0016 −0.0002) (1.0014*** 0.0716 (0.0002) (0.0048 −0. For minimizing risk without reducing expected return.0003) (0.0391** (0.0143) (0.0046) (0.0323) (0.1431) (0.0002) (1.0013*** −0.0584) (0.0007) (0.0068) (0.0078*** −0.0007) (0.37e-05) (0.0046) (0.0054*** (0. Africa-Gold Panel A: Mean equation c0 0.1014*** 0.0003) (0.0029*** 0.0037*** −0.0036*** −0.0018) (0.0041 0.12e-05) (0.0242*** −0.1130) (0.0003) α1 0.2008*** (0.0003) γ3 −0.9980*** 0.0058*** (0.0468) (0.0003) (0.5182*** 0.0082*** 0.0322) (0.00021) (1.0054*** (0.0203*** 0.0419) ψ4 0.0002) (0.0393) ψ2 −0.0129 0.0055*** 0.0442) (0.0043) (0.0007) (0.0023) (0.0928*** 0.1111*** 0.9976*** 1.19e-05) (0. respectively.1714 S.0067*** −0.0424) ψ3 0.0055*** −0.21e-05) (0.0003) γ2 −0.0069 0.0415*** −0. Table 7.1041) (0.0002) (1.0542*** −0.0039) (0.0055*** −0.9823*** 0.0013*** −0.0075) ψ1 −0.0065*** (0.0041*** −0. we compute optimal portfolio weights and hedge ratios for designing optimal hedging strategies.0087) (0. Financial and economic events21 Events Time periods Dot-com bubble 31/1/2000-27/09/2002 The global financial crisis 1/8/2007-4/11/2009 First phase of Eurozone sovereign debt crisis 5/11/2009-22/4/2010 Second phase of Eurozone sovereign debt crisis 2/5/2011-31/12/2011 Table 8.0029*** −0.0675) (0.0079*** −0.0326) (0.0478) (0.0003) (0.0168*** 0. it is assumed that an investor is holding a set . KANG ET AL.0370 −0.0013*** −0.9643*** (0.0071) α2 −0. Impact of global financial crisis on dynamic correlations between BRICS and gold markets Brazil-Gold Russia-Gold India-Gold China-Gold S.0156) Panel B: Variance equation α0 0.0395) (0.0021) (0.0788 −0. H. Thus.0002) (1.0012*** −0.0289 0.0046) (0. To manage the risk of both the BRICS and commodity markets more efficiently.0118) (0.0146) (0.1868 0.0765) (0.0007) (0.0051 0.2839*** (0. we consider a portfolio construction of BRICS stocks and commodity assets.0284*** (0.1266*** −0.0328 0.0055*** −0.0003) γ4 −0. For this article.0007) (0.1694*** −0. we use the estimates of the trivariate DCC- FIAPARCH model.0121 0.0341) γ1 −0.1375*** 0.2531) (0.0026) (0.23e-05) (0. building an optimal portfolio by making risk management and portfolio allocation decisions requires a preliminary and accurate estimate of the temporal covariance matrix.0080*** −0.0017) (0.0345) ϕ1 0.1165) (0.0003) Note: ** and *** indicate significance at the 5 percent and 1 percent levels.3442) (0.1145*** (0.0054*** −0.

0073*** 0.0308 0.9838*** 0.0003*** (0.0079*** −0.0005) (0.0324*** 0.0994) (0.0024*** −0.0011*** −0.0080*** (0.0062*** (0.0012) γ3 −0.1336) 0.0081*** 0.0131) (0.0291*** −0.0260) −0.28e-05) (0.4027** 0.0008) (0.0112) (0.0004) (0.0074) (0.25e-05) (0.0004) (0. For each commodity-stock pair.2358*** (2.0025) Note: See Table 9.0040) λ1 −0. Africa-Oil Panel A: Mean equation c0 0. From the budget constraint.0066) (0.0385) (0.00012*** −0.0495) Panel B: Variance equation α0 0.3948) (0.1415) (0.0004) (0.1416) (0.0191) λ2 −0.0004) (0.0203*** −0.0004) (0.27e-05) (0.0322) (0.0038) α1 0. and the conditional covariance between the commodity and the stock at time t.0035) (0.0316) λ4 0.0712*** (0.0017*** (0.0217) ϕ1 1.0179) (0.0380) (0.1899*** −0. the conditional volatility of the stock. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1715 Table 9. C (10) ht  2hCS t þ ht S : 1 wCt > 1 where hCt .0117*** −0. Impact of global financial crisis on dynamic correlations between BRICS and oil markets Brazil-Oil Russia-Oil India-Oil China-Oil S.0091** 0.0264) λ3 0. the portfolio weight of the holdings of commodity assets is given by: 8 h S  h CS < 0 wCt < 0 wt ¼ C C t t .0001) (5.0730*** −0.0245) (0.002*** 0.0622*** (0.0228 0. Following Kroner and Ng (1998).0428*** (0.3947) (0.0017*** −0. we consider the beta hedge approach of Kroner and Sultan (1993) in order to minimize the risk of this portfolio (BRICS stocks and commodity assets).0391** (0.0073*** −0.0008 0.0089*** (0.17e-05) (0.0081*** −0.0521) (0.0238 0.0020*** 0.0531) (0.0073*** −0.9738*** (0.0073*** −0.0263) 0.0207) (0.4302*** (0.0064) (0. We measure how a long .1153*** 0.0011) (0.0012*** −0.0004) (0.0013*** −0.0002*** 0.0001) (5. hSt and hCS t are the conditional volatility of the commodity markets.0040 0.0343*** 0.0007) γ2 −0. all information needed to compute wCt is obtained from the trivariate DCC-FIAPARCH model under Student-t innovations.0004) (0.0004) α2 −0.0134 0.0086*** (0.1462*** −0.0041) (0.0607*** −0.0079*** −0.0079) (0.0014*** −0. As for the hedge ratios.1669*** 1.0004) (0.0012*** −0.6038*** −0.0004) (0.1901) (0. respectively.0041) (0.1071) γ1 −0.1195 (0.0031*** −0.0073*** −0.0002) (0.9780*** 0.0079*** −0.0002) (5. with wt ¼ wCt 0  wCt  1 .0057) γ4 −0.9985*** 0. the optimal weight of the stock is equal to ð1  wCt Þ .0009 −0.0004) (0.0163 (0.0012*** −0.0001) (5. of BRICS stocks and wishes to hedge her position against unfavorable effects with commodity assets.0064) (0.0001) (5.23e-05) (0.0179*** (0.0056 0.0234** 0.0105) (0.

the highest average value of the optimal weights for the portfolio of the India-oil pair is 0. the lowest average hedge ratio observed.6433 0.1040 China-Oil 0.6329 0.1749 China-Gold 0.1655 0. Figures 4 and 5 represent the evolution over time of the hedge ratios between the BRICS stock market and commodity pairs.2788 0. the results suggest 24.1694 0.3497 0. relatively. indicating that commodity risk can be hedged effectively by taking a short position in stock markets. As shown in Table 10. H.1895 0.3151 Russia-Gold 0. the results suggest that the most effective strategy for hedging the risk associated with oil price fluctuation is a short position in the Indian stock market. that is: hCS βt ¼ t : (11) hCt Table 10 summarizes the average value of the optimal weight of the commodity assets (gold and oil) and the hedge ratios. These figures indicate that investors should adjust their portfolio structure and hedging positions according to stock market conditions (i.2519 0. Looking at the average values of the hedge ratios.2309 0. Taken together.1241 0.1716 S.e. KANG ET AL. For example. meaning that 64. lower over financial and economic events (the gray shaded periods in Table 7). Optimal portfolio weights and hedge ratios for the commodity markets and BRICS stock markets Optimal portfolio weight Hedge ratio Mean St.4174 (S. Dev Mean St.2419 0.0878 (India-oil).0878 0. estimated from the multivariate DCC-FIAPARCH model.1452 position (buy) of one dollar in the oil futures market should be hedged by a short position (sell) of βt dollar in the stock markets.2078 India-Oil 0.2451 0. Note that the gray bands correspond to periods associated with of the financial and economic events in Table 7. Africa-gold) to a minimum value of 0.1812 0. the hedge ratios of BRICS stocks-gold pairs in Figure 4 are.3126 0.1723 0. On the one hand.. This value indicates that a one-dollar long position (buy) in the gold market should be shorted (sold) by a 42 cent investment in the South African stock market.19 percent should be invested in gold and 75.1884 0.1335 0. bull or bear markets). based on the trivariate DCC-FIAPACH model estimations.2213 Brazil-Oil 0.67 percent should be held in the Indian stock market.81 percent should be invested in the Brazilian stock market. In contrast.2888 0. Dev Brazil-Gold 0.2882 India-Gold 0.1686 0. Table 10.2419). the optimal hedge ratios range from a maximum value of 0.1640 0. the highest average hedge ratio (the most expensive hedge) is observed for the S.5237 0.1695 0. These hedge ratios are generally low. Africa-Gold 0. Except for the first phase of the Eurozone sovereign debt crisis.2169 0.1102 S.1859 Russia-Oil 0. Africa-gold pair (0. the lowest average optimal weight is observed for the Brazil-gold pair (0.1525 0. implies that a one-dollar long in the oil market should be hedged with a short position of < 9 cents in the stock market.4174 0.1598 0. 0.1600 0.6433. in this case.5488 0.3385 0.0878 (India-oil). the hedge ratios of BRICS stocks-gold pairs show .2699 S.4174).33 percent should be invested in the oil market and the remaining portion of 35. Africa-Oil 0. In contrast.

the growth of the BRICS economies depends on oil price changes. as the BRICS stock markets are more volatile than the U. stock market. Aloui. suggesting that oil is an ineffective hedge asset against the BRICS stock market risk In summary. First. so investors seek a safe haven asset such as gold (Hood and Malik 2013. On the other hand. Reboredo 2013). implying that gold serves as an effective hedge in periods of stock market turmoil. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1717 Figure 4. a downward pattern. Time-varying hedge ratios between the BRICS and gold markets.S. our findings are inconsistent with that of Chkili. Second. the hedge ratios of BRICS stocks-oil pairs in Figure 5 show an upward pattern during the GFC and ESDC periods. which concludes that oil served as an effective commodity hedge asset against the volatility of the U. Conclusions This article investigates the time-varying volatility properties and dynamic conditional correlations among the BRICS stock markets and commodity markets. . Investors pay higher oil hedging costs in bearish markets.S. and Nguyen (2014). over the turbulent 2000–13 period. There are several reasons for this difference. investors require and demand more from a hedge against the price changes in BRICS markets. stock market.

emphasizing the importance of using the FIAPARCH model in analyzing the linkages between the BRICS stock markets and commodity markets. indicating that investors should adjust their portfolio structure and hedging positions to correspond with stock market conditions (bullish or bearish markets).1718 S. the results show that the dynamic correlations between the commodity and BRICS stock markets vary over time. with respect to portfolio management. Time-varying hedge ratios between the BRICS and oil markets. Second. our empirical results confirm the presence of the leverage effects and fractional integration in the conditional volatility of all markets. Figure 5. the results from the DCC-FIAPARCH model display significant time-varying correlations between the BRICS stock markets and com- modity markets. For example. and are sensitive to major financial and economic events. H. we find significant variability in hedging positions. Third. These results provide several implications for portfolio investors dealing with the BRICS stock markets and commodity markets when forecasting portfolio market risk exposures and determining the existence of diversification benefits in these markets. KANG ET AL. investors in the BRICS countries can transfer funds to the gold market in order to hedge their investments against extreme stock market . Our empirical results are summarised as follows. First. we analyze optimal weights and hedge ratios for optimal portfolios to minimise the exposure to portfolio risk. In particular. Furthermore. using the trivariate DCC-FIAPARCH model.

Jouini. and Nguyen 2012. and Simos 2013). MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1719 exposure. Aloui. asymmetry.org/). Celık 2012. Aloui.. Joëts. Wang and Moore 2012. 6. correlation estimates from the DCC model are widely applied in measuring hedge ratios across different financial markets (Arouri. Notes 1. Creti. and Ben Hamida 2015). The Student-t distribution is estimated with the parameter ν representing the number of degrees of freedom (df) and measuring the degree of leptokurtosis displayed by the density (see Fiorentini. Source: Energy Information Administration (http://www. Based on the Akaike (AIC) and Schwarz Bayesian information (BIC) criteria. and Calzolari (2003) for the multivariate Student-t density function). the investors may adopt an international diversification strategy by including commodity assets in their portfolios and building optimal portfolio designs accordingly.g. To conserve space. 4. The FIAPARCH specifications are suitable for capturing stylized facts like long memory. Chkili. and Nguyen (2014). Aloui. 2013. Chkili.gov/). 3. the forecasting superiority of FIAPARCH on other GARCH models is supported by Conrad.eia. Although many studies use various multivariate GARCH models in order to estimate DCCs among financial markets during the crisises (e. and Hilu 2015). Sentana. and leverage effects. and Nguyen 2011. The fractional differencing operator ð1  LÞd is most conveniently . 5. and Mignon 2013. Sadorsky 2014). Source: International Monetary Fund (http://www. and Zeng (2011) and Chkili. In addition. and Nguyen 2014. and Floros 2011. Hwang et al. Maghyereh. 2015. In order to avoid greater risks. One of the main advantages of this model is that it accounts for the long-memory in the conditional variance (Dimitriou. the order of the AR process in the return equations was set at one lag. Hammoudeh. Aloui. Kenourgios. Jouini and Harrathi 2014. Karanasos. Awartani. Use of a Student-t distribution allows modeling of the excess leptokurtosis which is not captured by the ARCH process (Filis. 2.imf. Degiannakis. the results are not reported here but they are available from the authors upon request.

. If αdcc þ βdcc ¼ 1 . Karanasos. This implies that the multi- variate DCC-FIAPARCH model is misspecified to estimate the conditional covariance among three variables. βdcc measures the lingering effect of the impact of a shock on conditional correlations.t depends on the significant values of αdcc and βdcc . If both the coefficients αdcc and βdcc are insignificant or negative values. d. 1Þ was chosen by minimizing the information criterion including the Akaike information criterion (AIC) and the Schwarz information criterion (SIC). and Nguyen 2014. expressed in terms of the hypergeometric d P1 Γðjd Þ P1 d j P1 ðaÞ ðÞ j function: ð1  LÞ ¼ F ðd. 10. Karanasos. 11. αdcc indicates the short-run volatility impact. Conrad. 8. with ðbÞ0 ¼ 1 and ΓðÞ is the gamma function. LÞ ¼ Γðd ÞΓðjþ1ÞL ¼ j ð1Þ Lj . 1. which indicates persistence in the conditional correlation process (Dimitriou and Kenourgios 2013. To avoid mismatching dates by excluding the holidays of different countries where there was no national trading. The first part of Equation (7) represents the volatility which is the sum of individual FIAPARCH likelihoods. The multivariate DCC-FIARPARCH model is based on the approximate Quasi Maximum Likelihood Estimation (QMLE) method as implemented in the OxMetrics module G@RCH 6 by Laurent (2009). 1. zÞ ¼ j j z ðcÞj j! is the j¼0 j¼0 j j¼0 Gaussian hypergeometric series. (1996. Kenourgios and Dimitriou 2015). and Lee 2015). 2012) into three subsample periods in relation to the global financial crisis of 2008–2009. Kenourgios. The strength of correlation ρij. βÞ satisfies the inequality constraints presented in Conrad and Haag (2006). can be very misleading when long- memory. 7. p. the positive constraint for conditional variances is not valid in the multivariate DCC-FIAPARCH model.t is nonstationary. and Karoglou In press. 12.” 9. Aloui. being confined to only considering the extreme cases I ð0Þ and I ð1Þ or stable GARCH and IGARCH processes. and Zeng (2011) note that a sufficient condition for the conditional variance of the FIAPARCH model to be positive almost surely for all t is that γ >  1 and the parameter combination ðϕ. For example. c. Yfanti. b. Dimitriou. one may use the exponential smoothing estimator (Kim. Gilenko and Fedorova (2014) consider dividing the whole period (April 14. 21) state that “For both the mean and the variance. 13. Note that the lag order ð1. qij. 15. we assume that during such days the value of the corresponding index remains constant and equal to its closing value on the last trading day before the holiday. where F ða. 2003– July 27. but eventual mean-reverting processes are generating the observed data. Chkili. 14. and Simos 2013. Baillie et al. implying the persistence of the standardized residuals from the previous period. d. If there is a holiday on Friday. Kim. then the price value of the last day of trading is used for that day. that is. 16. ðbÞj is the shifted factorial defined as ðbÞj ¼ j1i¼0 ðb þ iÞ.

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Note: The shaded areas highlight regimes of excess volatility according to the Markov switching dynamic regression model. MODELING TIME-VARYING CORRELATIONS IN VOLATILITY 1723 Appendix Figure A1. . Regimes of BRICS and commodity markets’ conditional volatilities.

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