Abstract:
This paper aims to investigate the mechanisms underlying the dynamic co-movement between commodity and stock markets based on the funding liquidity theory. Our results show that the correlation between commodity and equity markets experiences huge fluctuations since 2000 and 17% of variation in correlation can be explained by changes in the liquidity index constructed in this paper. When the liquidity situation deteriorates, the correlation between commodity and stock markets significantly increases. Moreover, the impact of market status on the correlation is also driven by liquidity factors. Our findings indicate that liquidity shocks have become an important channel to connect the commodity market with the external financial markets. This study not only sheds lights on the correlations between commodity and stock markets, but also provides new evidence for the integration of commodity markets with external financial markets.
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