The relationship between energy and equity markets: Evidence from volatility impulse response functions

- We examine multivariate BEKK-GARCH model of energy and equity indices.
- Energy volatility responds strongly to very low equity return shocks.
- Equity volatility responds modestly to energy shocks.
- Dynamic hedge ratios indicate energy is generally a poor hedge of US Equity Index.
- Low correlation between energy and equity except during the financial crisis period (2008-2010).

This paper examines the relationship between the energy and equity markets by estimating volatility impulse response functions from a multivariate BEKK model of the Goldman Sach's Energy Index and the S&P 500; in addition, we also calculate the time varying conditional correlations and time varying dynamic hedge ratios. From volatility impulse response functions, we find that low S&P 500 returns cause substantial increases in the volatility of the energy index; however, we find only a weak response from S&P 500 volatility to energy price shocks. Moreover, our dynamic hedge ratio analysis suggests that the energy index is generally a poor hedging instrument.