Threshold Cointegration in BRENT crude futures market

Mamatzakis, E and Remoundos, P (2010): Threshold Cointegration in BRENT crude futures market.

Abstract

This paper, using a threshold vector error-correction (TVECM) model, examines whether BRENT crude spot and futures oil prices are cointegrated. By employing this methodology we are able to evaluate the degree and dynamics of transaction costs resulting from various market imperfections. TVECM model is applied on daily spot and futures oil prices covering the period 1990-2009. The hypothesis we test is to what extent BRENT crude is indeed an integrated oil market in terms of threshold effects and adjustment costs. Our findings support that market follows a gradual integration path. We find that BRENT crude spot and futures are cointegrated, though two regimes are clearly identified. This implies that a threshold exists and it is indeed significant. Adjustment costs in the error correction are present, and they are valid at the typical regime that is the dominant, and as a result should not be ignored.

• Item Type: MPRA Paper
• Language: English
• Keywords: Threshold Cointegration, BRENT crude futures, Non-normality, ML Estimation.
• Subjects: C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; E - Macroeconomics and Monetary Economics > E2 - Consumption, Saving, Production, Investment, Labor Markets, and Informal Economy > E27 - Forecasting and Simulation: Models and Applications; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E37 - Forecasting and Simulation: Models and Applications

References

Abosedra, S., and Baghestani, H. 2004. On the predictive accuracy of crude oil futures prices. Energy Policy, 32, 1389–1393.

Aslanidis, Nektarios, Georgios P. Kouretas. 2005. Testing for Two-regime Threshold Cointegration in the Parallel and Official Markets for Foreign Currency in Greece. Economic Modelling. c.22. s.4: 665-682.

Askari, H. and Krichene N., 2008. Oil Price Dynamics (2002-2006), Energy Economics, Elsevier, vol. 30(5), 2134-2153.

Chance, D.M., 1991. An Introduction to Options and Futures. Dryden Press, Chicago.

Chung, H., T.-W. Ho, and L.-J. Wei. 2005. “The dynamic relationship between the prices of ADRs and their underlying stocks: Evidence from threshold vector error correction model.” Applied Economics, 37(20):2387–2394.

Gregory, A. W., Hansen, B. E., 1996. Residual-based tests for cointegration in models with regime shifts. Journal of Econometrics, 70,99–126.

Gulen, S.G., 1998. Efficiency in the crude oil futures market. Journal of Energy Finance and Development, 3, 13–21.

Cifarelli, G. and Paladino G., 2008. Oil Price Dynamics and Speculation, A Multivariate Financial Approach, Università degli Studi di Firenze, Working Paper N. 15/2008.

Crowder, W. J., and Hamed, A., 1993. A Cointegration Test for Oil Futures Market Unbiasedness. Journal of Futures Market, 13: 933-941.

Cunado, ,PerezdeGracia,F., 2003.Do oil price shocks matter? Evidence for some European countries. Energy Economics25,137–154. Engle,

Granger,C.W.J., 1987.Cointegrationanderrorcorrection:representation, estimation and testing. Econometrica 55, 251–276.

Fama,E.F.,French,K.R., 1988. Permanent and temporary components of stock prices. Journal of Political Economy 96, 246–273.

Meyer, J., 2004. Measuring market integration in the presence of transaction Costs: A threshold vector error correction approach. Journal of Agricultural Economics 31(2-3):327–334.

Moosa, I.A. and Loughani, N.E., 1994. Unbiased and time varying risk premia in the crude oil futures market, Energy Economics, 16, 99–105.

Hamilton J., 2009. Causes and Consequences of the Oil Shock of 2007-08. Brookings Institute.

Im, Kyung So, Pesaran, M., Hashem and Shin, Yongcheol, 2003. Testing for unit roots in heterogeneous panels. Journal of Econometrics, vol. 115(1), pages 53-74, July.

Johansen, S., 1988. Statistical analysis of cointegrating vectors. Journal of Economic Dynamics and Control 12, 231–254.

Maslyuk, S. and R. Smyth, 2009. Cointegration between oil spot and future prices of the same and different grades in the presence of structural change. doi:10.1016/j.enpol.2009.01.013.

McAleer, M., Sequeira, J.M., 2004. Efficient estimation and testing of oil futures contracts in a mutual offset system. Applied Financial Economics 14, 953–962.

METI, (2008). Annual Energy Report, Japanese Ministry of Economy Trade and Industry.

Peroni, E., McNown, R.F., 1998. Non informative and informative tests of efficiency in three energy futures markets. Journal of Futures Markets 18, 936–964.

Quan, J., 1992. Two-step testing procedure for price discovery role of futures prices. Journal of Futures Markets 12, 139–149.

Schwartz, T.V., Szakmary, A.C., 1994. Price discovery in petroleum markets: arbitrage, cointegration and the time interval of analysis. Journal of Futures Markets 14, 147–167.

Sequeira, J.M., McAleer, M., 2000. A market-augmented model for SIMEX Brent crude oil futures contracts. Applied Financial Economics 10, 543–552.

Serletis, A., Banack, D., 1990. Market efficiency and cointegration: an application to petroleum markets. The Review of Futures Markets 9, 372–380.

Silvapulle, P., Moosa, I.A., 1999. The relationship between spot and futures prices: evidence from the crude oil market. Journal of Futures Markets 19, 175–193.

Sanders, D.R., Manfredo, M.R., Boris, K., 2008. Accuracy and efficiency in the U.S. Department of Energy's short-term supply forecasts. Energy Economics, 30, 1192–1207.

Switzer, L.N. and El-Khoury, M., 2006. Extreme Volatility, Speculative Efficiency, and the Hedging effectiveness of the Oil Futures Markets , Journal of future markets, 61-84.

Williams, J.L., 2009. Oil Price History and Analysis, WTRG Economics Website.

Wu, T. and McCallum, A., 2005, FRBSF Economic Letters, No 2005-38, 1-3.

Wu, J.-L., and P.-F. Chen. 2006. Price indices and nonlinear mean reversion of real exchange rates. Southern Economic Journal, 73, 461–471.