The volatility linkage between energy and agricultural futures markets with external shocks

• Published in: International review of financial analysis Vol. 68; p. 101317
• Main Authors: Han, Liyan, Jin, Jiayu, Wu, Lei, Zeng, Hongchao
• Format: Journal Article
• Language: English
• Published: Elsevier Inc 01.03.2020
• Subjects: Agricultural futures; Energy futures; External shocks; Shale gas revolution; Volatility linkages; Energy futures; External shocks; Agricultural futures; Volatility linkages; Shale gas revolution
• ISSN: 1057-5219; 1873-8079
• DOI: 10.1016/j.irfa.2019.01.011

This paper investigates the volatility linkage between energy and agricultural futures returns and how this linkage responds to external macroeconomic shocks. A framework combining the VARMA-BEKK-GARCH model and the Permanent-Transitory decomposition technology is employed to detect the volatility transmission, to decompose the volatility linkage into permanent and transitory components, and to examine the underlying determinants of the transitory volatility linkage. We have the following findings. A bidirectional volatility linkage between energy and agricultural futures returns exists and becomes more pronounced in recent years. The bidirectional linkage results from the co-movement effect induced by external shocks rather than from the substitution effect induced by the biofuel industry, and is not weakened by the shale gas revolution. Serving as proxies for external shocks from the world economy, trade, and financial markets, the CRB, BDI, and USDX indices provide strong explanatory power for the transitory volatility linkage, and the futures of these indices can be used to effectively and inexpensively hedge against the risks of the portfolios involving energy and agricultural futures. •We document a bidirectional volatility linkage between energy and agricultural futures returns.•We use the VARMA-BEKK-GARCH model to detect the volatility transmission.•We use the Permanent-Transitory decomposition technology to decompose the volatility linkage.•The CRB, BDI, and USDX indices provide strong explanatory power for the transitory volatility linkage.