Modelling Volatility Spillovers between Prices of Petroleum and Stock Sectors in Top Petroleum Exporting and Importing Nations: A Multivariate GARCH Comparison

Abstract

This study utilises multivariate GARCH approaches, namely VAR-BEKK-GARCH, VAR-GARCH, VAR-AGARCH and VAR-DCC-GARCH, to model bilateral return and volatility spillovers between petroleum prices and self-constricted stock sector indices of the largest two net petroleum exporters (Canada and Saudi Arabia) and two net petroleum importers (the United States and China) with developed and emerging markets. In addition, it quantifies optimal portfolio weights and hedge ratios, and compares the effectiveness of hedging strategies produced from estimates of each considered model. The empirical findings point to the presence of heterogeneous volatility interdependencies between prices of petroleum and stock sector indices, which are more evident for Canada and the United States. The optimal weight of petroleum is greater in portfolios comprising stock sector indices of Saudi Arabia and China, which also provide lower hedging costs, irrespective of the models applied. The time-varying figures of conditional correlations, portfolio weights and hedge ratios exhibit considerable variations, particularly during turbulent periods in the markets. Finally, the hedging strategies generated from the VAR-DCC-GARCH specification result in the greatest reduction of risks for portfolios involving stock sector indices of all countries.

Keywords: Petroleum prices, Stock sector returns, Volatility transmission, multivariate GARCH, Hedge ratios