In this study, we examine the hedging relationship between gold and US sectoral stocks during the COVID-19 pandemic. We employ a multivariate volatility framework, which accounts for salient features of the series in the computation of optimal weights and optimal hedging ratios. We find evidence of hedging effectiveness between gold and sectoral stocks, albeit with lower performance, during the pandemic. Overall, including gold in a stock portfolio could provide a valuable asset class that can improve the risk-adjusted performance of stocks during the COVID-19 pandemic. In addition, we find that the estimated portfolio weights and hedge ratios are sensitive to structural breaks, and ignoring the breaks can lead to overestimation of the hedging effectiveness of gold for US sectoral stocks. Since the analysis involves sectoral stock data, we believe that any investor in the US stock market that seeks to maximize risk-adjusted returns is likely to find the results useful when making investment decisions during the pandemic.
The literature on the response of financial markets, including the stock market, to the COVID-19 pandemic is fast growing, owing to its grave consequences. Several studies have examined the impact of the pandemic on financial markets (see for example, Ali et al., 2020; Al-Awadhi et al., 2020; Baig et al., 2020; Haroon and Rizvi, 2020a,b; He et al., 2020; Li et al., 2020; Narayan et al., 2020a,b; Mishra et al., 2020; Phan and Narayan, 2020; Prabheesh et al., 2020; Salisu and Akanni, 2020; Salisu et al., 2020a,b; Salisu and Sikiru, 2020; Salisu and Vo, 2020; Sharma, 2020; Zhang et al., 2020; Sikiru and Salisu, 2021; among others)1 and the evidence suggests a negative impact; consequently, the need to hedge against the risk associated with the pandemic becomes crucial.2 This is the motivation for our study. In response to this challenge, we consider gold to be a potential asset that can serve as a good hedge for stocks against the pandemic risk. The pioneering studies on the gold-stocks nexus (see for instance, McDonald and Solnik, 1977; Sherman, 1982; Jaffe, 1989; Chua et al., 1990) indeed support the inclusion of gold in the equities portfolio for the benefits of portfolio diversification and downside risk management.3,4 This continues to be emphasised in the recent literature with pieces of evidence of negative or low correlation of gold in the investment portfolio containing stocks (see for example, Joy, 2011; Reboredo, 2013; Beckmann et al., 2015; Bredin et al., 2015). This strand of the literature also finds support in the conceptual arguments, which suggest stock market hedging qualities of gold when its return is shown to be negative or uncorrelated with the stocks prices (or returns) (see Baur and Lucey, 2010; Baur and McDermott, 2010; Zagaglia and Marzo, 2013).5 In the class of traditional hedging assets, Shahzad et al. (2020), while not particularly considering the COVID-19 pandemic, have shown that gold offers more effective hedging benefits for G7 stock indices.