Return and Volatility Spillovers in Crude Market and Gold Markets

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Business and Information 2012 (Sapporo, July 3-5)

RETURN AND VOLATILITY SPILLOVERS IN CRUDE OIL MARKET AND GOLD MARKETS Tzu-Kuang Hsu Department of International Business, Chung Hua University, 707, Sec. 2, WuFu Rd., Hsinchu 300, Taiwan ROC hsutk@chu.edu.tw Chin-Chang Tsai Chung Hua University PH.D. Program of Technology Management 707, Sec. 2, WuFu Rd., Hsinchu 300, Taiwan ROC 1435fu@gmail.com

ABSTRACT Much of the economics literature asserts that crude oil and gold prices consistently affect global economic growth. Most studies have examined the existence of a long-term co-integration relationship between these two commodities’ index returns, but none of the studies investigates their short-term volatility spillover effect relationship, if any. The current study fills this research gap by using an exponential generalized autoregressive conditional heteroskedasticity model with two variables (Bi-EGARCH) to examine the series-based short-term relationships (i.e., the return rate, volatility interrelation, and spillover effect) between crude oil and gold prices. The results indicated that crude oil and gold returns in our model containing an unrestricted intercept and an unrestricted trend were found to have a long-term co-integration relationship. In the short-term volatility leverage effect, the gold and oil return rate were found to be significant and have the same market leverage effect. Moreover, the standardized residual from the previous gold and oil session had a significant impact on current volatility. Regarding the cross-market spillover effect, the impact of the market retreat of oil indices on the conditional volatility of gold indices was weakened and found to be insignificant, but the impact of the market advance of gold indices on the conditional volatility of oil indices, owing to the sign effect, was found to be significant and to have more stronger. Keywords: Crude oil prices, Gold prices, An exponential generalized autoregressive conditional heteroskedasticity model,

INTRODUCTION Economic development closely relates to energy acquisition, and today, crude oil is the primary energy source worldwide. Crude oil’s price changes directly influence the price of commodities worldwide, as well as the economic growth of every country. Before 1999, oil prices declined only in times of economic downturn. The price of crude oil, however, started rising in 2007 and, as a result, global prices have been rising drastically since then. The price of oil exceeded $100US per barrel for the first

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Business and Information 2012 (Sapporo, July 3-5)

time, in February 2008; it later peaked at $145.66US in July of the same year. This caused the prices of commodities to rise continuously, prompting an unstable global economy that showed a downward trend. However, by December 2008, the oil price had fallen back to $31.12US per barrel. Hamilton (2009) explains that the high oil prices in 2008 were part of a bubble, and that three key variables were responsible for them in the summer of 2008: oil’s low price elasticity of demand; the strong growth in demand for oil from China, the Middle East, and various newly industrialized nations; and the failure of global oil production to increase. Today’s international markets and global economic data suggest the presence of slight inflation and stagnant growth, and oil prices rose from $84US per barrel in February 2011 to $98US in November 2011 (see Figure 1).

Figure 1 Crude oil prices (1984–2010) Regarding gold prices in the late 1980s, the strong US dollar made for weaker gold values. Therefore, when international events occurred, gold prices did not respond drastically. By the 1990s, the world’s political scene and economics had begun to stabilize, and investment tools had also emerged to counter inflation. These circumstances prompted a decline in the gold market: the gold price fell to between $300US and $400US per ounce, on account of inflation. However, in...
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