Modeling Conditional Correlations for Risk Diversification in Crude Oil Markets

26 Pages Posted: 10 May 2009  

Chia-Lin Chang

National Chung Hsing University - Department of Applied Economics, Department of Finance

Michael McAleer

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

Roengchai Tansuchat

Faculty of Economics - Chiang Mai University

Date Written: May 8, 2009

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), VARMA-GARCH 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.

Keywords: conditional correlations, crude oil spot prices, forward prices, futures prices, risk diversification

JEL Classification: C22, C32, G17, G32

Suggested Citation

Chang, Chia-Lin and McAleer, Michael and Tansuchat, Roengchai, Modeling Conditional Correlations for Risk Diversification in Crude Oil Markets (May 8, 2009). Available at SSRN: https://ssrn.com/abstract=1401331 or http://dx.doi.org/10.2139/ssrn.1401331

Chia-Lin Chang (Contact Author)

National Chung Hsing University - Department of Applied Economics, Department of Finance ( email )

Taichung, Taiwan
China

Michael McAleer

Erasmus University Rotterdam - Erasmus School of Economics, Econometric Institute ( email )

Rotterdam
Netherlands

Tinbergen Institute

Rotterdam
Netherlands

University of Tokyo - Centre for International Research on the Japanese Economy (CIRJE), Faculty of Economics

Tokyo
Japan

Roengchai Tansuchat

Faculty of Economics - Chiang Mai University ( email )

Thailand

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