International Journal of Economics and Finance; Vol. 5, No. 9; 2013 ISSN 1916-971X E-ISSN 1916-9728 Published by Canadian Center of Science and Education 28 Conditional Correlations between Stock Index, Investment Grade Yield, High Yield and Commodities (Gold and Oil) during Stable and Crisis Periods Sukriye Tuysuz 1 1 Department of International Finance, Yeditepe University, Istanbul, Turkey Correspondence: Sukriye Tuysuz, Department of International Finance, Yeditepe University, Istanbul, Turkey. E-mail: sukriye.tuysuz@yeditepe.edu.tr Received: June 7, 2013 Accepted: July 12, 2013 Online Published: August 26, 2013 doi:10.5539/ijef.v5n9p28 URL: http://dx.doi.org/10.5539/ijef.v5n9p28 Abstract We analyzed the conditional correlation between the returns of five assets (S&P 500, investment grade bond, high-yield bond, crude oil and gold). The results obtained with the AGDCC model lead to several conclusions. The correlations between the assets retained are feeble during stable periods. In periods of financial crisis with sustained economic growth, adding gold, crude oil, high-yield bonds and investment-grade bonds in a portfolio can improve the benefit of this portfolio. However, investors should adjust their portfolio when concerns about the economic growth appear as crude oil is negatively correlated with the returns of the S&P 500 and the high-yield bond during crisis periods, but it is positively correlated with those assets’ returns when the crisis is coupled with economic recession. Regarding the high yield bond, it losses less value than stock index during bear market and it appreciates as much as stock index during bull market. As for the gold, it is a strong safe haven during periods characterized by fears of recession, concerns regarding the credit markets, target rate cuts, as well as uncertainties regarding inflation rate. Thus, gold was not a safe haven during the Asian and the Russian crises, whereas it was a weak safe haven during the dot-com crisis and a strong safe haven during the subprime crisis. During these crises, due to the "flight-to-quality" gold value appreciated strongly compared to the other assets retained. Furthermore, with the aggravation of the economic and financial situation the negative impacts of the subprime crisis have spread from stock market and high-yield bonds to other financial markets (contagion), except to the gold market. Keywords: conditional correlation, DCC Model, financial crisis, stock index, high-yield bond, investment-grade bond, crude oil, gold 1. Introduction The benefits of portfolio diversification depend strongly on the correlation between the returns on the assets composing the portfolio. Lesser are correlated assets composing a portfolio, more effective is the risk reduction of loss of this portfolio and then better is the benefit of diversification. Correlations change over time in response to their fundamentals, and are mainly related to economic/monetary and financial integration as well as the economic and financial situation (Erb et al., 1994; Longin and Solnik, 1995; Goetzmann et al., 2005). Investors need constantly to determine the correlations across asset classes and readjust their portfolios in order to improve the trade-off between risk and returns, mainly during financial crises when the risk reduction of loss and the improvement of benefits of diversification are needed most. The analysis of the benefit of a portfolio diversification is then based on the examination of the correlations across different assets’ returns composing a portfolio. In the empirical literature, authors have mainly considered the interdependence between two asset classes, and particularly between government bonds and stock indices (Note 1). Few authors have been attracted by the correlation between stock index (or equities) and crude oil (Jones and Kaul, 1996; Faff and Brailsford, 1999; Sadorsky, 1999) or by the correlation between stock index (or equities) and gold (Jaffe, 1989; Johnson and Soenen, 1997; Davidson et al., 2003). In order to complete the existing studies, we examine in this paper the correlation across five US assets; which are the high yield bond, the investment grade bond, the S&P 500, crude oil and gold. Compared to several authors who considered government bonds in