Reserve currency and the time-varying link between uncertainties in commodity and financial markets

Option-implied volatilities are widely used to examine the dynamics of uncertainty in global markets. This study aims to investigate how the reserve currency (US dollar) influences the time-varying relationship between uncertainties (implied volatilities) in commodity markets (oil and gold markets) and financial markets (currency and stock markets). For robustness, we also control for other risk factors such as financial stress, monetary circumstances, economic policy uncertainty, and business cycle dynamics. To this end, we first derive the dynamic conditional correlations between the uncertainties in oil, gold, stock, and currency markets. We then use the autoregressive distributed lag model to explore the influence of US dollar appreciations on the dynamic conditional correlations between these uncertainties. Our baseline findings demonstrate that US dollar appreciations are the main factor in intensifying the dynamic conditional correlations of the uncertainties. To ensure accuracy, we apply impulse-response analysis, which validates the findings of our analysis. We observe that the dynamic conditional correlations of the uncertainties exhibit a stronger reaction to a shock in the US dollar, in comparison with a shock in other risk factors. The results provide useful implications for portfolio managers. The main implication is that the increased US dollar value reduces the diversification benefits in options markets.