Price Discovery and Volatility Spillovers in Indian Spot-Futures Commodity Market

P., Srinivasan (2011): Price Discovery and Volatility Spillovers in Indian Spot-Futures Commodity Market. Published in: The IUP Journal of Behavioral Finance , Vol. 9, No. 1 (24 March 2012): pp. 70-85.

Abstract

The present paper examines the price discovery process and volatility spillovers in Indian spot-futures commodity markets through Johansen cointegration, Vector Error Correction Model (VECM) and the bivariate EGARCH model. The study uses four futures and spot indices of the Multi Commodity Exchange of India (MCX), representing relevant sectors like agriculture (MCXAGRI), energy (MCXENERGY), metal (MCXMETAL), and the composite index of metals, energy and agrocommodities (MCXCOMDEX). Johansen cointegration test confirms the presence of long-term equilibrium relationships between the futures price and its underlying spot price of the commodity markets.The VECM shows that commodity spot markets of MCXCOMDEX, MCXAGRI, MCXENERGY and MCXMETAL play a dominant role and serve as effective price discovery vehicle, implying that there is a flow of information from spot to futures commodity markets. Besides, the bivariate EGARCH model indicates that although bidirectional volatility spillover persists, the volatility spillovers from spot to the futures market are dominant in case of all MCX commodity markets.

• Item Type: MPRA Paper
• Language: English
• Keywords: Price Discovery, Volatility Spillover, VECM, Bivariate GARCH, Commodity Market
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C58 - Financial Econometrics; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G13 - Contingent Pricing ; Futures Pricing

References

Assoe K (2001), “Volatility Spillovers between Foreign Exchange and Emerging Stock Markets”, Cahier de Recherche 2001-04, CETAI, HEC-Montreal.

Bollerslev T (1986), “Generalized Autoregressive Conditional Heteroscedasticity”, Journal of Econometrics, Vol. 31, pp. 307-327.

Booth G G, T Martikainen and Y Tse (1997), “Price and Volatility Spillovers in Scandinavian Markets”, Journal of Banking & Finance, Vol. 21, pp. 811-823.

Chan K Chan K C and Karolyi A G (1991), “Intraday volatility in the stock index and stock index futures markets”, Review of Financial Studies, Vol. 4, pp. 657–684.

Chan K (1992), “A Further Analysis of the Lead-Lag Relationship between the Cash Market and Stock Index Futures Market”, Review of Financial Studies, Vol. 5, No. 1, pp. 123-152.

Cheung Y and Lai K (1993), “Finite sample sizes of Johansen’s Likelihood Ratio Tests for Cointegration”, Oxford Bulletin of Economics and Statistics, Vol. 55, pp. 313-328.

Clinton W and Michael M (2002), “Cointegration analysis of metals futures.” Mathematics and Computers in Simulation, Vol. 59, pp. 207-221.

Dickey D A and Fuller W A (1979), “Distribution of the Estimations for Autoregressive Time Series with a Unit Root”, Journal of the American Statistical Association, Vol. 47, pp. 427-431.

Ding Z, Granger C W J and Engle R F (1993), “A long memory property of stock market returns and a new model”, Journal of Empirical Finance, Vol. 1, pp.83–106.

Engel R F and Granger C W J (1987), “Cointegration and error correction representation, estimation and testing”, Econometrica, Vol. 55, pp. 251-276.

Engle R F and Ng V K (1993), “Measuring and Testing the impact of news on volatility”, Journal of Finance, Vol. 48, pp. 1749-1748.

Engle R F (1982), “Autoregressive conditional heteroscedasticity with estimates of the variance of United Kingdom inflation”, Econometrica, Vol. 50, pp. 987–1008.

Fu L Q and Qing Z J (2006), “Price discovery and volatility spillovers: Evidence from Chinese spot-futures markets”, China & World Economy, Vol. 14, No.2, pp.79-92.

Garbade K D and Silber W L (1983), “Dominant satellite relationship between live cattle cash and futures markets”, The Journal of Futures Markets, Vol. 10, No.2, pp. 123-136.

Ghosh A (1993), “Hedging with stock index futures: Estimation and forecasting with error correction model”, Journal of Futures Market, Vol. 13, No. 7, pp. 743–752.

Gonzalo J (1994), “Five Alternative Methods of Estimating Long-Run Equilibrium Relationship”, Econometrica, Vol. 60, pp. 203-233.

Granger C (1986), “Developments in the Study of cointegrated Variables”, Oxford Bulletin of Economics and Statistics, Vol. 48, pp. 213-227.

Greene W H (1997), “Econometric analysis (3rd edition)”, Engelwood Cliffs, NJ: Prentice Hall.

Hamao Y, R Masulis and V Ng (1990), “Correlations in Price Changes and Volatility Across International Stock Markets”, Review of Financial Studies, Vol. 3, No.2, pp. 281-307.

Iyer V and Pillai A (2010) "Price discovery and convergence in the Indian commodities market", Indian Growth and Development Review, Vol. 3, No.1, pp. 53 – 61.

Johansen S and Juselius K (1990), “Maximum likelihood estimation and inference on cointegration—with applications to the demand for money”, Oxford Bulletin of Economics and Statistics, Vol. 52, pp. 169-210.

Johansen S (1988), “Statistical Analysis and Cointegrating Vectors”, Journal of Economic Dynamics and Control, Vol. 12, No.2-3, pp. 231−254.

Kanas A (2000), “Volatility Spillovers between Stock Returns and Exchange Rate Changes: International Evidence”, Journal of Business Finance & Accounting, Vol. 27, No.3&4, pp. 447-467

Karolyi G A (1995), “A Multivariate GARCH Model of International Transmission of Stock Returns and Volatility: The Case of the United States and Canada”, Journal of Business & Economic Statistics, Vol. 13, No.1, pp. 11-25.

Koutmos G, Booth G G (1995), “Asymmetric Volatility Transmission in International Stock Markets”, Journal of International Money and Finance, Vol.14, No.5, pp. 747-762.

Kumar S and Sunil B (2004), “Price discovery and market efficiency: evidence from agricultural future commodities”, South Asian Journal of Management, Vol. 11, No.2, pp. 27-49.

Lee T and Tse Y (1996), “Cointegration Tests with Conditional Heteroscedasticity”, Journal of Econometrics, Vol. 73, pp. 401-410.

Lien D (1996), “The effect of the cointegrating relationship on futures hedging: a note”, Journal of Futures Markets, Vol. 16, No. 7, pp. 773–780.

Lien D and Luo X (1994), “Multi-period Hedging in the Presence of Conditional Heteroskedasticity”, The Journal of Futures Market, Vol. 14, No. 8, pp. 927-956.

Ljung G M and Box G E P (1978), “On a Measure of a Lack of Fit in Time Series Models”, Biometrika, Vol. 65, pp. 297–303.

McLeod A I and Li W K (1983), “Diagnostic Checking ARMA Time Series Models Using Squared-Residual Autocorrelation”, Journal of Time Series Analysis, Vol. 4, No. 4, pp. 269-273.

Moosa I A (2002), “Price Discovery and Risk Transfer in the Crude Oil Futures. Market: Some Structural Time Series Evidence”, Economic Notes, Vol. 31, pp. 155-165.

Praveen D G and Sudhakar A (2006), “Price Discovery and Causality in the Indian Derivatives Market”, ICFAI Journal of Derivatives Markets, Vol. 3, No.1, pp. 22-29.

Ramaprasad B (2001), “Return and volatility dynamics in the spot and futures markets in australia: An intervention analysis in a bivariate EGARCH-X framework.” Journal of Futures Markets, Vol. 21, No.9, pp. 833-850.

Shihabudheen M T and Padhi P (2010), “Price Discovery and Volatility Spillover Effect in Indian Commodity Market”, Indian Journal of Agricultural Economics, Vol. 65, No.1, pp. 101-117.

Srinivasan P (2009), “An Empirical Analysis of Price Discovery in the NSE Spot and Future Markets of India”, The ICFAI Journal of Applied Finance, Vol. 15, No.11, pp. 24-36.

Susmel R and R F Engle (1994), “Hourly Volatility Spillovers Between International Equity Markets”, Journal of International Money and Finance, Vol. 13, pp. 3-25.

Theodossiou P and U Lee (1993), “Mean and Volatility Spillovers Across Major National Stock Markets: Further Empirical Evidence”, Journal of Financial Research, Vol. 16, No.4, pp. 337-350

Thomas S and Karande K (2001), “Price discovery across multiple spot and futures markets”, IGIDR Working Paper, Mumbai, India, http//www.igidr.ac.in.

Wahab M and M Lashgari (1993), “Price dynamics and error correction in stock Index and stock Index futures markets: A cointegration approach”, Journal of Futures Markets, Vol. 13, No. 7, pp. 711–742.

Zapata H, T R Fortenbery and D Armstrong (2005), “Price Discovery in the World Sugar Futures and Cash Markets: Implications for the Dominican Republic”, Staff Paper No. 469, Department of Agricultural & Applied Economics, University of Wisconsin-Madison.

Zhong M, Darrat, A F and Otero R (2004), “Price discovery and volatility spillovers in index futures markets: some evidence from Mexico”, Journal of Banking and Finance, Vol. 28, pp. 3037-3054.