The Dependence Between The Chinese Stock Price And Commodity Price:Implications For Risk Management

With the development and maturity of Chinese financial market,the liberalization and integration of financial market determine that the relationship between financial submarkets is becoming more inseparable.Therefore,the research on the dependence between different financial assets has been the important subject of empirical finance.The research on the dependence between financial assets helps to analyze the mutual influence between financial markets and help investors to make portfolio selection and risk management.As the factors that change commodity price is quite different from stocks and the ability of resisting inflation,more investors are willing to add commodities to their portfolios which can diversify their investments and prevent extreme risks.The dependence between the two markets has become the focus of investor attention.The domestic scholars mainly focus on the spillover effect and the commodity financialization between the stock market and the commodity market,but few of researchs focus on the dependence between the two markets.In particular,in order to prevent extreme risk events,investors are interested in the tail dependence and risk management strategies,which the researcs is few.To fill the research gap,the paper aim to describe the dependence through the dynamic copula function model as accurately and comprehensively.Moreover several portfolios are establishde and evaluated.The paper studies the dependence between the Shanghai Composite Index and the Commodity Futures Index of the total market and five sub-sectors.First,the descriptive statistical analysis shows that the distributions of index yields are not subject to the normal distribution and have the characteristics of autocorrelation and conditional heteroskedasticity.Therefore,this paper uses AR(1)-APGARCH(1,1)-skewed-t to construct the marginal distributions of asset returns and then applies four dynamic copulas to capture the dependent structure between the two markets.At the same time,the autoregressive model for parameters in the copula function is defined to explore whether dependence between the two markets has time-varying characteristics.The empirical results show that there is a weak positive correlation between the stock market and the commodity market in China,and the dependence is time-varying.There is an obvious character that the dependence is various in the different periods.After the outbreak of the financial crisis in 2008,the level of dependence increased significantly and fell until in 2014.Therefore,the traditional static correlation coefficient analysis can not effectively describe the dynamic relationship between the two markets,it is so necessary to carry out dynamic copula function analysis.For the dependent structure,the commodity market and the oil sub-market both have symmetrical dependent structure with the Chinese stock markets,and the tail dependence is not obvious.However the other commodity sub-market(non-ferrous metals,agricultural products,soft goods and chemical sub-market)have significant tail dependence with the stock market.Therefore when the financial extreme risk events such as the financial crisis happened,the correlation between stock market and these commodity sub-markets will be significantly enhanced,and investors will face the risk that two markets may fall at the same time.Based on the conditional volatilities of asset returns and the dependence between Chinese stock market and commodity market obtained from the optimal copula,this paper then explores the application of commodities in risk management.Firstly,we calculate the dynamic optimal portfolio weights and dynamic hedging ratios to construct the dynamic optimally-weighted portfolio and dynamic hedged portfolio,meanwhile the equally-weighted portfolio is considered as well.Then this paper uses the three indicators including the risk-adjusted return,risk reduction efficiency and extreme down-risk reduction efficiency to evaluate the three portfolios.The empirical results show that the dynamic optimally-weighted portfolio constructed by the stock assets and oil commodity assets is found to be the best risk management strategy,which can significantly improve the risk-return of Chinese stock investment and reduce its extreme downside risks.