Estimating Volatility Persistence in Oil Prices Under Structural Breaks

Policy makers and financial market participants are interested in knowing how shocks affect the volatility of oil prices over time. We accurately compute the volatility persistence by incorporating endogenously determined structural breaks into a GARCH model. Contrary to previous findings, we find that oil shocks dissipate very quickly but have a strong initial impact. Understanding this behavior is not only important for derivative valuation and hedging decisions but for broader financial markets and the overall economy, for which there are significant consequences.

[1]  David E. Rapach,et al.  Structural breaks and GARCH models of exchange rate volatility , 2008 .

[2]  G. C. Tiao,et al.  Use of Cumulative Sums of Squares for Retrospective Detection of Changes of Variance , 1994 .

[3]  Perry Sadorsky.  Oil price shocks and stock market activity , 1999 .

[4]  Charles M. Jones,et al.  OIL AND THE STOCK MARKETS , 1996 .

[5]  J. Poterba,et al.  The Persistence of Volatility and Stock Market Fluctuations , 1984 .

[6]  J. Duan.  THE GARCH OPTION PRICING MODEL , 1995 .

[7]  C. Granger,et al.  Nonstationarities in Stock Returns , 2005, Review of Economics and Statistics.

[8]  Sylvain Leduc,et al.  A quantitative analysis of oil-price shocks, systematic monetary policy, and economic downturns , 2001 .

[9]  Basis variations and regime shifts in the oil futures market , 2003 .

[10]  T. Bollerslev,et al.  Generalized autoregressive conditional heteroskedasticity , 1986 .

[11]  Farooq Malik,et al.  Shock and volatility transmission in the oil, US and Gulf equity markets , 2007 .

[12]  A. Banerjee,et al.  Modelling structural breaks, long memory and stock market volatility: an overview , 2005 .

[13]  Hui Guo,et al.  Oil price volatility and U.S. macroeconomic activity , 2005 .

[14]  Perry Sadorsky,et al.  Modeling and forecasting petroleum futures volatility , 2006 .

[15]  Hélyette Geman,et al.  WTI crude oil Futures in portfolio diversification: The time-to-maturity effect , 2008 .

[16]  James D. Hamilton.  What is an Oil Shock? , 2000 .

[17]  F. Diebold,et al.  VOLATILITY AND CORRELATION FORECASTING , 2006 .

[18]  Stephen Gray.  Modeling the Conditional Distribution of Interest Rates as a Regime-Switching Process , 1996 .

[19]  T. Bollerslev,et al.  ANSWERING THE SKEPTICS: YES, STANDARD VOLATILITY MODELS DO PROVIDE ACCURATE FORECASTS* , 1998 .

[20]  J. David Cabedo,et al.  Estimating oil price ‘Value at Risk’ using the historical simulation approach , 2003 .

[21]  T. Mikosch,et al.  Nonstationarities in Financial Time Series, the Long-Range Dependence, and the IGARCH Effects , 2004, Review of Economics and Statistics.

[22]  Bradley T. Ewing,et al.  Volatility transmission between oil prices and equity sector returns , 2009 .

[23]  J. Peter Ferderer,et al.  Oil price volatility and the macroeconomy , 1996 .

[24]  C. Inclan,et al.  Detecting volatility changes across the oil sector , 1996 .

[25]  J. Wooldridge,et al.  Quasi-maximum likelihood estimation and inference in dynamic models with time-varying covariances , 1992 .

[26]  G. Schwert.  Business Cycles, Financial Crises, and Stock Volatility , 1989 .

[27]  R. Engle.  Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation , 1982 .

[28]  Sangyeol Lee,et al.  The Cusum of Squares Test for Scale Changes in Infinite Order Moving Average Processes , 2001 .

[29]  R. Pindyck.  VOLATILITY IN NATURAL GAS AND OIL MARKETS , 2003 .

[30]  C. Inclan,et al.  Volatility in Emerging Stock Markets , 1997, Journal of Financial and Quantitative Analysis.

[31]  Christopher G. Lamoureux,et al.  Persistence in Variance, Structural Change, and the GARCH Model , 1990 .

[32]  E. Ghysels,et al.  Detecting Multiple Breaks in Financial Market Volatility Dynamics , 2002 .

[33]  Ben Jacobsen,et al.  Striking Oil: Another Puzzle? , 2003 .

[34]  Eric Hillebrand.  Neglecting parameter changes in GARCH models , 2005 .