Forecasting Commodity Market Synchronization with Commodity Currencies: A Network-Based Approach

• Published in: Entropy
• Main Authors: Nicolas S. Magner, Nicolás Hardy, Jaime Lavin, Tiago Ferreira
• Format: Text
• Language: English
• Published: Multidisciplinary Digital Publishing Institute 2023
• Subjects: commodity markets; returns synchronization; networks analysis; forecasting models; commodity currencies; Canada; New Zealand; Norway; Iceland
• Online Access: https://doi.org/10.3390/e25040562

This paper shows that some commodity currencies (from Chile, Iceland, Norway, South Africa, Australia, Canada, and New Zealand) predict the synchronization of metals and energy commodities. This relationship links the present-value theory for exchange rates and its connection with commodity export economies’ fundamentals, where prospective commodity price fluctuations affect exchange rates. Predicting commodity market return synchronization is critical for dealing with systemic risk, market efficiency, and financial stability since synchronization reduces the benefits of diversification and increases the probability of contagion in financial markets during economic and financial crises. Using network methods coupled with in-sample and out-of-sample econometrics models, we find evidence that a fall in the return of commodity-currencies (dollar appreciation) predicts an increase in commodity market synchronization and, consequently, in commodity market systemic risk. This discovery is consistent with a transitive capacity phenomenon, suggesting that commodity currencies have a predictive ability over commodities that extend beyond the commodity bundle that a country produces. The latter behavior would be exacerbated by the high financialization of commodities and strong co-movement of commodity markets. Our paper is part of a vigorously growing literature that has recently measured and predicted systemic risk caused by synchronization, combining a complex systems perspective and financial network analysis.