Asset Market Linkages in a Regime Switching Environment: Evidence from Commodity and Stock Markets in India

Abstract

(ProQuest: ... denotes formulae omitted.)1.IntroductionCommodities have emerged as a significant mode of alternative investment today all over the world. While they have been in existence in many of the developed markets, commodities, in Indian context have seen a brisk growth in the last few years, which is quite visible in the volumes of contracts traded. Majority of the Literature on Indian commodity markets has focused on the issue of market efficiency, price volatility, price discovery, market integration, Contango and Normal backwardation and a number of studies have been done in this context. These markets were found to be efficient and doing well on price discovery Ahuja (2006); Bose(2008); Karande (2006); Sahi & Raizada (2006); Nath & Lingareddy (2008) ,Brajesh Kumar(2009); Srinivasan (2012) but relatively poorly on hedging effectiveness (Bose (2009); Kumar (2010); Yaganti and Kamaiah 2012);Gupta & Singh(2007); Aggarwal N, Jain S, Thomas S (2014). During the crises of 2008, when the stock markets were performing badly and the SENSEX was giving a return of 0.7%, agricultural and metal indices of MCX were providing returns to the extent of 18% and 17% respectively. It was during that time commodity markets attracted the attention of the Indian investors and garnered an image of a separate asset class that provided diversification benefits. Thus, it becomes imperative to delve deep into commodities and investigate its linkages with other asset classes in the Indian Context.In context of developed commodity markets, a number of researchers have confirmed that commodity prices tends to move in opposite direction with equity markets and exhibit zero or very low correlation with them Bodie & Rosansky(1980); Edwards & Park (1996); Lee,Leuthold. & Cordier(1986) ; Schneeweis and Spurgin (2000); Jensen et al. (2002) ;Henry G. Jarecki 2007); Anson & Mark (1999) Jensen, Johnson & Mercer,(2009); McCown and Zimmerman (2006);Gorton & Rouwenhorst(2006); Jalil, Ghani, Daud, & Ibrahim (2009); Park & Ratti, (2008); Wang, Wang, & Huan (2010). In addition, several researchers have also confirmed that returns for commodities show positive correlation with unexpected inflation and exhibit better performance under high inflation times Greer (1978); Bodie (1983); Halpern and Warsager (1998); and Gorton, Hayashi & Rouwenhorst (2007). However, in Indian context, this concept of the comovement of Commodity and equity markets remains relatively unexplored. The only studies in this context was done by Mishra (2008) and Brajesh kumar (2008) who investigated the portfolio performance of Indian commodity markets and found favourable results in context of diversification benefits of commodities.One of the major drawbacks of the aforementioned studies is that they have assumed a symmetric and linear relationship between commodity and equity markets and examined their co-movement solely on the basis of correlation. These studies assume the presence of uniform economic state throughout the duration of the study. Researches done by Hui-Ming Zhu , Keming Yu (2012); Hsiang-Tai Lee(2010); Ramaprasad & Shawkat (2011) ; Levy& Kaplanski (2015) confirmed that the returns from commodity futures and stock market do not show a continuous trend but exhibit time varying behaviour i.e. the returns of stocks might be higher in certain economic conditions while it may fall as the economic environment changes due to financial crises, oil price rise, rupee depreciation etc. Similarly the returns from commodities is also subject to variation with changes in economic conditions Wai Mun Fong , Kim Hock See (2002); Minh T. (2009); Nikos & Panos (2011); Kuang-Liang Chang (2012) ; Shiu-Sheng Chen (2010); Lin & Wesseh (2013) ; Gargano,, Pettenuzzo, & Timmermann (2014) due to which the basic assumptions of stationary and linearity of time series models gets refuted.Although in context of developed commodity markets, recently a number of researchers has ve pointed out that correlations between commodity and other asset classes is time varying and different in bearish and bullish markets, restrictive and expansive monetary policy, pre and post crises ,time varying interest rates Jensen et al. …