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Modelling Conditional Correlations for Risk Diversification in Crude Oil Markets

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Author Info

  • Chia-Lin Chang

    (Department of Applied Economics, National Chung Hsing University)

  • Michael McAleer

    (Econometric Institute, Erasmus School of Economics, Erasmus University Rotterdam and Tinbergen Institute and Center for International Research on the Japanese Economy (CIRJE), Faculty of Economics, University of Tokyo)

  • Roengchai Tansuchat

    (Faculty of Economics, Maejo University and Faculty of Economics, Chiang Mai University)

Abstract

This paper estimates univariate and multivariate conditional volatility and conditional correlation models of spot, forward and futures returns from three major benchmarks of international crude oil markets, namely Brent, WTI and Dubai, to aid in risk diversification. Conditional correlations are estimated using the CCC model of Bollerslev (1990), VARMAGARCH model of Ling and McAleer (2003), VARMA-AGARCH model of McAleer et al. (2009), and DCC model of Engle (2002). The paper also presents the ARCH and GARCH effects for returns and shows the presence of significant interdependences in the conditional volatilities across returns for each market. The estimates of volatility spillovers and asymmetric effects for negative and positive shocks on conditional variance suggest that VARMA-GARCH is superior to the VARMA-AGARCH model. In addition, the DCC model gives statistically significant estimates for the returns in each market, which shows that constant conditional correlations do not hold in practice.

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Bibliographic Info

Paper provided by Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo in its series CARF F-Series with number CARF-F-162.

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Length: 27 pages
Date of creation: Aug 2009
Date of revision:
Handle: RePEc:cfi:fseres:cf162

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References

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  1. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, vol. 31(3), pages 307-327, April.
  2. Francesco Audrino & Fabio Trojani, 2007. "A general multivariate threshold GARCH model with dynamic conditional correlations," University of St. Gallen Department of Economics working paper series 2007 2007-25, Department of Economics, University of St. Gallen.
  3. Lanza, Alessandro & Manera, Matteo & McAleer, Michael, 2006. "Modeling dynamic conditional correlations in WTI oil forward and futures returns," Finance Research Letters, Elsevier, vol. 3(2), pages 114-132, June.
  4. Massimiliano Caporin & Michael McAleer, 2009. "Do We Really Need Both BEKK and DCC? A Tale of Two Covariance Models," Documentos del Instituto Complutense de Análisis Económico 0904, Universidad Complutense de Madrid, Facultad de Ciencias Económicas y Empresariales.
  5. Fong, Wai Mun & See, Kim Hock, 2002. "A Markov switching model of the conditional volatility of crude oil futures prices," Energy Economics, Elsevier, vol. 24(1), pages 71-95, January.
  6. Tanchanok Khamkaew & Roengchai Tansuchat & Chia-Lin Chang & Michael McAleer, 2009. "Modelling Conditional Correlations in the Volatility of Asian Rubber Spot and Futures Returns," CARF F-Series CARF-F-175, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo, revised Nov 2009.
  7. McAleer, Michael, 2005. "Automated Inference And Learning In Modeling Financial Volatility," Econometric Theory, Cambridge University Press, vol. 21(01), pages 232-261, February.
  8. Sadorsky, Perry, 1999. "Oil price shocks and stock market activity," Energy Economics, Elsevier, vol. 21(5), pages 449-469, October.
  9. McAleer, Michael & Chan, Felix & Marinova, Dora, 2007. "An econometric analysis of asymmetric volatility: Theory and application to patents," Journal of Econometrics, Elsevier, vol. 139(2), pages 259-284, August.
  10. Sébastien Laurent & Luc Bauwens & Jeroen V. K. Rombouts, 2006. "Multivariate GARCH models: a survey," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 21(1), pages 79-109.
  11. Sadorsky, Perry, 2006. "Modeling and forecasting petroleum futures volatility," Energy Economics, Elsevier, vol. 28(4), pages 467-488, July.
  12. Thomas Lee & John Zyren, 2007. "Volatility Relationship between Crude Oil and Petroleum Products," Atlantic Economic Journal, International Atlantic Economic Society, vol. 35(1), pages 97-112, March.
  13. Ling, Shiqing & McAleer, Michael, 2002. "NECESSARY AND SUFFICIENT MOMENT CONDITIONS FOR THE GARCH(r,s) AND ASYMMETRIC POWER GARCH(r,s) MODELS," Econometric Theory, Cambridge University Press, vol. 18(03), pages 722-729, June.
  14. Li, W K & Ling, Shiqing & McAleer, Michael, 2002. " Recent Theoretical Results for Time Series Models with GARCH Errors," Journal of Economic Surveys, Wiley Blackwell, vol. 16(3), pages 245-69, July.
  15. Matteo Manera & Michael McAleer & Margherita Grasso, 2006. "Modelling time-varying conditional correlations in the volatility of Tapis oil spot and forward returns," Applied Financial Economics, Taylor & Francis Journals, vol. 16(7), pages 525-533.
  16. Ling, Shiqing & McAleer, Michael, 2003. "Asymptotic Theory For A Vector Arma-Garch Model," Econometric Theory, Cambridge University Press, vol. 19(02), pages 280-310, April.
  17. McAleer, Michael & Chan, Felix & Hoti, Suhejla & Lieberman, Offer, 2008. "Generalized Autoregressive Conditional Correlation," Econometric Theory, Cambridge University Press, vol. 24(06), pages 1554-1583, December.
  18. Engle, Robert, 2002. "Dynamic Conditional Correlation: A Simple Class of Multivariate Generalized Autoregressive Conditional Heteroskedasticity Models," Journal of Business & Economic Statistics, American Statistical Association, vol. 20(3), pages 339-50, July.
  19. Narayan, Paresh Kumar & Narayan, Seema, 2007. "Modelling oil price volatility," Energy Policy, Elsevier, vol. 35(12), pages 6549-6553, December.
  20. Nelson, Daniel B, 1991. "Conditional Heteroskedasticity in Asset Returns: A New Approach," Econometrica, Econometric Society, vol. 59(2), pages 347-70, March.
  21. Hui Guo & Kevin L. Kliesen, 2005. "Oil price volatility and U.S. macroeconomic activity," Review, Federal Reserve Bank of St. Louis, issue Nov, pages 669-84.
  22. Michael McAleer & Suhejla Hoti & Felix Chan, 2009. "Structure and Asymptotic Theory for Multivariate Asymmetric Conditional Volatility," Econometric Reviews, Taylor & Francis Journals, vol. 28(5), pages 422-440.
  23. Engle, Robert F, 1982. "Autoregressive Conditional Heteroscedasticity with Estimates of the Variance of United Kingdom Inflation," Econometrica, Econometric Society, vol. 50(4), pages 987-1007, July.
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Citations

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Cited by:
  1. Chang, C. & McAleer, M.J. & Tansuchat, R., 2010. "Analyzing and Forecasting Volatility Spillovers and Asymmetries in Major Crude Oil Spot, Forward and Futures Markets," Econometric Institute Research Papers EI 2010-14, Erasmus University Rotterdam, Erasmus School of Economics (ESE), Econometric Institute.
  2. Lu, Jin-Ray & Lee, Pei-Hsuan & Chuang, I-Yuan, 2011. "Estimation of oil firm's systematic risk via composite time-varying models," Mathematics and Computers in Simulation (MATCOM), Elsevier, vol. 81(11), pages 2389-2399.
  3. Matteo Manera & Marcella Nicolini & Ilaria Vignati, 2012. "Returns in commodities futures markets and financial speculation: a multivariate GARCH approach," Quaderni di Dipartimento 170, University of Pavia, Department of Economics and Quantitative Methods.
  4. Roengchai Tansuchat & Chia-Lin Chang & Michael McAleer, 2010. "Crude Oil Hedging Strategies Using Dynamic Multivariate GARCH," Working Papers in Economics 10/03, University of Canterbury, Department of Economics and Finance.
  5. Wang, Yudong & Wu, Chongfeng, 2012. "Forecasting energy market volatility using GARCH models: Can multivariate models beat univariate models?," Energy Economics, Elsevier, vol. 34(6), pages 2167-2181.
  6. Jin, Xiaoye & Xiaowen Lin, Sharon & Tamvakis, Michael, 2012. "Volatility transmission and volatility impulse response functions in crude oil markets," Energy Economics, Elsevier, vol. 34(6), pages 2125-2134.
  7. Chia-Lin Chang & Michael McAleer & Roengchai Tansuchat, 2010. "Analyzing and Forecasting Volatility Spillovers, Asymmetries and Hedging in Major Oil Markets," Working Papers in Economics 10/19, University of Canterbury, Department of Economics and Finance.
  8. Chang, Kuang-Liang, 2012. "Volatility regimes, asymmetric basis effects and forecasting performance: An empirical investigation of the WTI crude oil futures market," Energy Economics, Elsevier, vol. 34(1), pages 294-306.

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