The dynamic network connectedness and hedging strategies across stock markets and commodities: COVID-19 pandemic effect

Abstract

PurposeThe aim of this study was to investigate the dynamic network connectedness between stock markets and commodity futures and its implications on hedging strategies. Specifically, the authors studied the impact of the 2014 oil price drop and coronavirus disease 2019 (COVID-19) pandemic on risk spillovers and portfolio allocation among stock markets (United States (SP500), China (SSEC), Japan (Nikkei 225), France (CAC40) and Germany (DAX)) and commodities (oil and gold).Design/methodology/approachIn this study, the authors used the Baba, Engle, Kraft and Kroner–generalized autoregressive conditional heteroskedasticity (BEKK–GARCH) model to estimate shock transmission among the five financial markets and the two commodities. The authors rely on Diebold and Yılmaz (2014, 2015) methodology to construct network-associated measures.FindingsRelying on the BEKK–GARCH, the authors found that the recent health crisis of COVID-19 intensified the volatility spillovers among stock markets and commodities. Using the dynamic network connectedness, the authors showed that at the 2014 oil price drop and the COVID-19 pandemic shock, the Nikkei225 moderated the transmission of volatility to the majority of markets. During the COVID-19 pandemic, the commodity markets are a net receiver of volatility shocks from stock markets. In addition, the SP500 stock market dominates the network connectedness dynamic during the COVID-19 pandemic, while DAX index is the weakest risk transmitter. Regarding the portfolio allocation and hedging strategies, the study showed that the oil market is the most vulnerable and risky as it was heavily affected by the two crises. The results show that gold is a hedging tool during turmoil periods.Originality/valueThis study contributes to knowledge in this area by improving our understanding of the influence of fluctuations in oil prices on the dynamics of the volatility connection between stock markets and commodities during the COVID-19 pandemic shock. The study’s findings provide more implications regarding portfolio management and hedging strategies that could help investors optimize their portfolios.