A Dynamic Conditional Correlation between Commodities and the Islamic Stock Market

Abstract

Following the outbreak of the financial crisis and falling prices in the financial markets, we noticed the existence of several recent studies on the relationships between commodity and stock markets. More specifically, our paper is most closely related to those documenting the importance of the links between Islamic capital markets and commodities. To this end, we focus on the dynamics of the correlations between commodities and Islamic indexes. From a methodological viewpoint, we start this paper by examining the approaches of EC-GARCH and DCC-GARCH, which allow us to assess, respectively, the causality and how the correlations between commodity and stock returns evolve over time. To test our models empirically, we build a daily data set, consisting of commodity and stock prices. The sample period used in this paper is May 19, 2010 – February 14, 2014. Our empirical evidence supports the view that volatilities of commodity returns are strongly correlated to those of Islamic indexes. In fact, correlations between commodity and Islamic stock markets are time-varying and highly volatile. Our paper contributes importantly to the empirical literature dealing with the links between commodity and stock markets and the literature supporting the financialization of commodity markets.