XIAOYE JIN (PhD candidate) Xiaoye.jin.1@city.ac.uk 22 June 2011

1. Crude Oil Markets Integration on Second Moment: Evidence from Volatility Transmission and Volatility Impulse Response Functions XIAOYE JIN (PhD candidate) Xiaoye.jin.1@city.ac.uk 22 June 2011 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

2. Outline 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

3. Increasing integration of major financial markets and crude oil as alternative asset in investment portfolio Necessity to analyze crude oil market in higher moment: cost of capital, investment and leverage decisions, optimal hedge ratio, and portfolio weights Motivation 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

4. To investigate the volatility transmission within and across crude oil markets using the Full-BEKK model To apply the Volatility Impulse Response Function (VIRF) to uncover the impact of historical innovations on conditional volatility Objective 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

5. Crude oil markets integration and volatility transmission • “Law of one price”: Adelman (1992), Ewing & Harter (2000), Bachmeire & Griffin (2006) • Volatility transmission: Chang et al. (2009) • Volatility impulse response function (VIRF) • Impulse response function (IRF): Sims (1980), Doan et al. (1984) • Non-linear IRF: Gallant et al. (1993), Koop et al. (1996) • VIRF: Hafner and Herwartz (2006) Literature Review 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

6. One month future WTI, Dubai and Brent • Daily closing price from 1 July 2005 to 28 February 2011 • Future prices are preferable to spot prices (Schwarz and Szakmary, 1994) • The same closing time (NYMEX close) is critical (Lin and Tamvakis, 2001) Data 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

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8. The BEKK model and VECH Representation Econometric Methodology 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

9. Volatility Impulse Response Function ( Hafner and Herwartz, 2006) Econometric Methodology 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

10. Properties of VIRF Econometric Methodology 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

11. Return dynamics Empirical Results 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

12. 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

13. Volatility dynamics Empirical Results 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

14. 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

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17. Volatility impulse response function analysis • 2008 Financial crisis (Lehman Brother Bankruptcy) • Deepwater Horizon oil spill Empirical Results 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

18. 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

19. 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

20. Volatility impulse response distributions Empirical Results 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

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22. 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

23. Volatility impulse response analysis for VaR analysis Empirical Results 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

24. 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

25. We observe that Brent and Dubai crude are highly responsive to market shocks, and WTI shows the least responsiveness of the three benchmarks. These fitted distributions show that the probability of observing a large positive impact of a shock is very low while the probability of a relatively smaller positive impact is much higher. The VRIF shows that only “large” shock, which is derived from the smaller possibility of occurrence, will result in an increase in expected conditional volatilities. Conclusions 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

26. Data frequency. Conditional covariances and correlations. Expansion of standard BEKK model. Higher moments of a distribution (Jondeau and Rockinger, 2006). Future Research 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011

27. Thanks! 34th IAEE International Conference Institutions, Efficiency and Evolving Energy Technologies Stockholm June 19 – 23, 2011