The spillover effects across natural gas and oil markets: Based on the VEC–MGARCH framework

Abstract This paper empirically investigates both price and volatility spillover effects in a comprehensive VEC–MGARCH framework. The hedging strategy is further discussed using the spillover effects. Crude oil and natural gas markets of US, Europe and Japan are examined for regional segmentation and different pricing mechanisms of natural gas. Our results show that the European and Japanese gas prices are cointegrated with Brent oil prices, but US gas price is decoupled from oil due to natural gas market liberalization and shale gas expansion. In all cases, the results support the presence of price spillover from crude oil markets to natural gas markets, but a reverse relationship does not exist. The asymmetric price spillover effects might be explained by the relative size of each market. It was also found that the volatility in oil market seems to spillover to the natural gas market, and vice versa, in both US and Europe. On the contrary, volatility seems to be independent in natural gas and oil markets in Japan. The difference in the results of the volatility spillover effects could be explained by the pricing mechanism of natural gas, especially the risk avoidance mechanism in gas pricing in Japan. The risk management performance of hedging strategy is remarkable considering volatility spillover.

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