Efficient markets are more connected: An entropy-based analysis of the energy, industrial metal and financial markets

Abstract

This is the first article to jointly study the efficiency and connectedness of commodity markets, using the novel method combination of fuzzy entropy and multivariate transfer entropy analysis. We examine this issue in the nexus of energy, industrial metals and financial markets. We identify the existence of a relationship between market efficiency and connectedness, which opens a new direction for investigating the sources of market connectedness. The results indicate that the efficient markets process more information and are more connected in the system. Moreover, efficient markets are net transmitters of information to the less efficient markets. Stronger connectedness does not necessarily exist within the same market sector but emerges among the efficient markets irrespective of their sector categorization. The relationship between market efficiency and connectedness is more pronounced during extreme events. During the turbulence of COVID-19, there are stronger connectedness and higher information spillover from the efficient to less efficient markets. Specifically, we find the industrial metals are on average the most efficient sector, followed by the energy and then the financial markets. The relatively more efficient natural gas and industrial metal markets exhibit strong connectedness and transmit information to the less efficient crude oil and financial markets. These findings imply that the market connectedness can be the result of information dissemination and alleviate the concerns that higher connectedness may compromise the price discovery mechanism.