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Inside the Black Box: the Price Linkage and Transmission between Energy and Agricultural Markets

  • Du, Xiaodong

Despite a growing literature on the integration of energy and agriculture, few have rigorously examined structural changes in the evolution of related energy and agricultural prices. Motivated by strong comovement and increasing volatility of energy and agricultural prices, we examine dynamic evolutions of ethanol, gasoline, and corn prices over the period of March 2005 – March 2011. A structural change is found around March 2008 in the pairwise dynamic correlations between the prices in a multivariate GARCH model. A structural VAR (SVAR) model is then estimated on two subsamples, one before and one after the identified change point. Using the novel method of “identification through heteroscedasticity”, we exploit the time-varying price volatilities to fully identify the SVAR model. In the more recent period, ethanol, gasoline, and corn prices are found to be more closely linked. Specifically, ethanol (corn) shocks have the largest impact on corn (ethanol) price. The strengthened corn-ethanol relation can be largely explained by the new developments of the biofuel industry and related policy instruments. Variance decomposition shows that for each market a significant and relatively large share of the price variation could be explained by the price changes in the other two markets. For example, corn price changes explain 27% of the variation of ethanol prices, and shocks to ethanol price account for 23% of the variance of corn prices. The results are robust to the inclusion of seasonal dummies, and various representative macroeconomic and financial indicators.

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Paper provided by International Association of Agricultural Economists in its series 2012 Conference, August 18-24, 2012, Foz do Iguacu, Brazil with number 125146.

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Date of creation: Jun 2012
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Handle: RePEc:ags:iaae12:125146
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