Hedging US equity risk through energy and precious metals future contracts

Abstract

In this work, we examine the potential of various financial commodities to hedge on the equity risk of S&P500 stock index. Three alternative multivariate conditional volatility models are also used to estimate the dynamic conditional correlations and the time-varying covariance matrixes between S&P500 and commodities. We also show the implications of our results on portfolio management and risk hedging. The conditional covariance and variances are used to calculate the time-varying optimal hedge ratio and optimal portfolio weights. Finally, the effectiveness of these hedge ratios is studied in terms of risk reduction focusing on the periods of the Global Financial Crisis and the Covid-19 pandemic.