A common factor of stochastic volatilities between oil and commodity prices

Eunhee Lee, Doo Bong Han, Rodolfo M. Nayga, Jr

Research output: Contribution to journalArticle

1 Citation (Scopus)

Abstract

This article analyses the multivariate stochastic volatilities (SVs) with a common factor influencing volatilities in the prices of crude oil and agricultural commodities, used for both biofuel and nonbiofuel purposes. Modelling the volatility is crucial because the volatility is an important variable for asset allocation, risk management and derivative pricing. We develop a SV model comprising a latent common volatility factor with two asymptotic regimes with a smooth transition between them. In contrast to conventional volatility models, SVs are generated by the logistic transformation of latent factors, which comprise two components: the common volatility factor and an idiosyncratic component. We present a SV model with a common factor for oil, corn and wheat from 8 August 2005 to 10 October 2014, using a Markov chain Monte Carlo method to estimate the SVs and extract the common volatility factor. We find that the volatilities of oil and grain markets are persistent. According to the estimated common volatility factor, high volatility periods match the 2007–2009 recession and the 2007–2008 financial crisis quite well. Finally, the extracted common volatility factor exhibits a distinct pattern.

Original languageEnglish
Pages (from-to)1-13
Number of pages13
JournalApplied Economics
DOIs
Publication statusAccepted/In press - 2016 Oct 14

Fingerprint

Oil prices
Commodity prices
Stochastic volatility
Common factors
Factors
Stochastic volatility model
Markov chain Monte Carlo methods
Biofuels
Agricultural commodities
Corn
Recession
Multivariate stochastic volatility
Oil
Crude oil
Asset allocation
Smooth transition
Oil markets
Latent factors
Derivative pricing
Risk management

Keywords

  • common volatility factor
  • Oil and commodity prices
  • stochastic volatility

ASJC Scopus subject areas

  • Economics and Econometrics

Cite this

A common factor of stochastic volatilities between oil and commodity prices. / Lee, Eunhee; Han, Doo Bong; Nayga, Jr, Rodolfo M.

In: Applied Economics, 14.10.2016, p. 1-13.

Research output: Contribution to journalArticle

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