() and Paolo Zagaglia
Fabrizio Spargoli: Università Politecnica delle Marche, Postal: Università Politecnica delle Marche, Piazzale Martelli 8, 60121 Ancona, Italy
Paolo Zagaglia: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden, and the European Central Bank
Abstract: This paper studies the linkages between the prices of oil futures traded on the New York Mercantile Exchange and the Intercontinental Exchange of London. We estimate a structural BEKK-GARCH model that allows for non-zero correlation between the structural innovations. We identify the structural parameters through restrictions on the reduced-form GARCH model. We find that the oil futures traded on the NYMEX and ICE can be used for mutual hedging purposes only when the structural conditional variances of both innovations are modest and, as such, no turbulent events have taken place. Periods with positive structural correlations are instead associated with peaks in the structural conditional variance of both innovations. During times of market turmoil, the structural variance of the returns on NYMEX futures becomes larger than that of ICE futures. This means that, when there are common shocks to both markets, the NYMEX reacts more strongly than the ICE. Our empirical evidence explains the negative reduced-form correlation between the two returns which is observed in turbulent periods.
19 pages, August 14, 2007
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