Volatility Spillover Between Financial And Commodity Markets: A Theoretical Synthesis Of Transmission Mechanisms, Measurement Approaches, And Policy Implications

Abstract

This paper synthesises the theoretical literature on volatility spillover between financial and commodity markets in order to create a framework for the research on this subject, which has grown significantly since the global financial crisis of 2008 led to greater financialization of commodities. Volatility spillover encompasses the spread of volatility risk across markets, via channels such as investor behaviour, common macroeconomic shocks, and index funds and exchange-traded products (ETPs) that trade across markets. The review brings together three strands of literature: theoretical channels of communication (financialization, information transmission, behavioural contagion), the development of measurement methodology from the early multivariate GARCH frameworks to the Diebold–Yilmaz connectedness index and its time-varying parameter vector autoregressive (TVP-VAR) extension, and applied evidence from energy, precious metals, agriculture and cryptocurrency markets, with a particular emphasis on crisis periods such as COVID-19 and the Russia–Ukraine conflict. The synthesis suggests that the financial and commodity market connectedness is regime-dependent and ramps up markedly when systemic stress occurs, and that transactions between markets can flow from the financial to commodity markets or from the commodity to the financial markets, depending on the commodity sector and the nature of the shock. The paper ends with a discussion on gaps in methodology and policy implications in the context of diversifying portfolios, systemic risk regulation and the growing challenge for macroprudential policy to monitor and influence increasingly interconnected global markets.