Commodities Dynamic

Correlation and Volatility

Sultan Salem (University of Surrey, UK)
&
Abhishek Kumar(IGIDR, Mumbai)

Thursday, January 7, 2016

Motivation and Result

The research highlights a snap shot for time-varying of co-movement capturing correlation and volatility for various UK
metal commodities
Amid time series applications, the literature reveals the practicality for the Dynamic Conditional Correlation DCC
model developed by Engle (2001, 2002) and BEKK (named after Baba, Engle, Kraft and Kroner, 1990) as they can be
significant for a time series framework model to be utilized.
The research utilizes on CCC, DCC, BEKK, linear model and adapted CAPM by means of the GARCH applications.
Empirical analysis suggests that
1) There is a minimal co-movement correlation between crude oil commodity and metal commodities in UK.
2) Seemingly insignificant spillover volatility between crude oil commodity and metal commodities in UK.

Thursday, January 7, 2016

For each variable, the returns are denoted as the continuously compounded return for the commodities: crude oils
and top six precious metal commodities, and the financial and foreign exchange price index. The crude and metal
commodities, stock and foreign exchange rates returns are calculated in the following manner, written as:

= +
In which " is the daily commodity price at time period . Moreover, the commodity returns are computed based on
continuous compounding measures for the commodity oil price (crude oils and metals).
Traditionally measuring volatility by the daily standard deviation of daily returns in the composite Commodities, stock
and financial Price Index. This is a measure of dispersion of daily returns about the average return for each day.
$200

Nominal brent crude prices/US$

$180
$160
$140
$120
$100
$80
$60
$40
$20
$0
Dec-89

Dec-95

Dec-01

Dec-07

Fig. 1: Average monthly nominal Brent Crude price (US-$) and standard deviation from 1989 to 2013
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

Dec-13

Unit Roots Tests ( KPSS, ADF, and PP)

Prices: Unit root tests not statistically significant, prices contain a unit root.
Returns: The ADF and PP unit root tests are statistically significant, returns do not contain unit roots similar to KPSS
test. (Excellent)
Table 7: Unit root tests : ADF and PP Test for Crude Oils Metals, and UK10YRB & Foreign Exchange

Returns

ADF test (t-statistics)

Phillips-Perron test

OILBREN

None
-70.06059

Constant
-70.07360

Constant and Trend

-70.06672

None
-70.06075

Constant
-70.07400

Constant and Trend

-70.06712

OILWTI

-70.97401

-70.98197

-70.97468

-71.31068

-71.34460

-71.33670

-57.11988

-57.13200

-57.12634

-62.00530
-52.48344

-61.99930
-52.36856

-61.99298
-52.36344

-69.14255

-69.16280

-69.15688

-69.43656

-69.46735

-69.47313

-76.35647

-76.36603

-76.35940

-72.33791

-72.34062

-72.33989

-68.89988
-71.58808

-68.89739
-71.58080

-68.89017
-71.57334

-69.02050

-69.02122

-69.01392

-73.15722

-73.16004

-73.15473

-66.33685

-66.36019

-66.35281

-69.40514

-69.40182

-69.39761

OILOPEC

-46.32218

-46.34171

-46.33740

AVRG3CRUDEOIL

-62.08272

-62.09643

-62.09028

AVRG13CRUDEOIL

-51.78012

-51.80389

-51.79873

PLATINUM

-69.13262

-69.14875

-69.14289

GOLD

-69.43069

-69.46242

-69.47255

SILVER

-76.38846

-76.39775

-76.39071

COPPER

-72.38500

-72.38654

-72.38515

NICKEL

-68.89621

-68.89364

-68.88655

ALUMINIUM

-71.56335

-71.55610

-71.54870

AVRGTOP6METALS

-69.01089

-69.01147

-69.00434

LMEINDX

-73.14901

-73.14957

-73.14389

UK 10 Year BOND

-66.38316

-66.40282

-66.39594

YUAN/POUND

-69.40243

-69.39910

-69.39666

Notes:

Entries in bold are significant at the 1%level. The p value results shows all variables are highly significant. Since p-value is less than 1%, 5% and 10% significance level. Null hypothesis: variable has unit root and non-stationary is rejected and the alternative
hypothesis: variable has no unit root and stationary is accepted. Therefore variables do not need to be first or second differenced at any level. T-statistics is one tailed test and is negative.

Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

Research Questions for Correlation and Volatility (G)ARCH Applications

One of the prevailing and widespread classifications:

1. Engle (1982) offered a prominent article by

contributing toward pioneering class stochastic
procedures named Autoregressive Conditional
Heteroscedasticity
(ARCH)
methods.
ARCH
processes are with mean zero, and serially
uncorrelated techniques while having non-constant
variances. For the aforementioned processes
belonging to a past period comparatively close to
the present contains recorded data regarding oneperiod anticipation variance.
2. The GARCH (p,q) model proposed by Bollerslev
(1986) will be utilized for the investigation of
volatile activities perseverance, The scope volume
for volatile activities perseverance can be computed
by the sum of the coefficients in variance
equation + .

Thursday, January 7, 2016

Research Question 1: Is the relationship between Brent Crude oil price volatility and UK 6 Metal
commodities Constant or Dynamic over time?

Research Question 2: Is the relationship between Brent Crude oil price volatility and UK market
Metal commodities Constant or Dynamic over time?

Research Question 3: Is the relationship between Brent Crude oil price volatility and UK Metal
commodities more dynamic during an Asian or Global shock over time?

Research Question 4: Is the relationship between Crude oil price volatility and UK Metal market
index return more dynamic during an Asian or Global financial crisis?

Research Question 5: Is the relationship between Crude oil price volatility and UK Metal market
index return more significant (Structural Break) during the Asian or Global
financial crisis?

Sultan Salem & Abhishek Kumar

CCC-GARCH Approach
Introduced by Bollerslev (1990) Constant conditional correlation GARCH (CCC-GARCH):
The conditional correlation being constant over time, also every conditional correlation coefficient is computed from the
standardised residuals GARCH (p,q), being constant conditional correlation matrix of the unconditional shocks," , compromising
total elements of , by means of depiction, equal to the conditional covariance matrix of the standardised shocks, " .

CCC: Returns correlation (Covariance) as constant and not time variant like the DCC
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

.5

.5

.4

.4

.4

.3

.3

.3

.2

.2

.2

.1

.1

.1

.0

.0

.0

-.1

-.1
1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

-.1

-.2
1996

1998

2000

2002

DCCorrelation(BRENT-PLATINUM)
CCCorrelation(BRENT-PLATINUM)

2004

2006

2008

2010

2012

2014

1996

1998

2000

DCCorrelation(BRENT-GOLD)
CCCorrelation(BRENT-GOLD)

2002

2004

2006

2008

2010

2012

2014

2012

2014

DCCorrelation(BRENT - SILVER)
CCCorrelation(BRENT - SILVER)

.8
.6
.4
.2
.0
-.2
-.4
1996

1998

2000

2002

2004

2006

2008

2010

2012

2014

DCCorrelations (B RE NT - LM E INDX)
CCCorrelations (B RE NT - LM E INDX)

.6

.8

.8

.6

.6

.4

.4

.2

.2

.1

.0

.0

.0

-.2

-.2

.5
.4
.3
.2

-.1

-.4
1996

-.2
1996

1998

2000

2002

2004

2006

2008

2010

Thursday, January 7, 2016

DCCorrelation(BRENT - COPPER)
CCCorrelation(BRENT - COPPER)

2012

2014

1998

2000

2002

2004

2006

2008

2010

DCCorrelation(BRENT - NICKEL)
CCCorrelation(BRENT - NICKEL)

Sultan Salem & Abhishek Kumar

2012

2014

-.4
1996

1998

2000

2002

2004

2006

2008

DCCorrelation(BRENT - ALUMINIUM)
CCCorrelation(BRENT - ALUMINIUM)

2010

DCC-GARCH Approach
The DCC-GARCH model introduced by Engle (2002) will be utilized to anticipate crude oil returns and commodities index returns.

A new model for measuring and predicting correlations as well as volatilities. This Dynamic Conditional
Correlation model or DCC, models the volatilities and correlations in two steps:

THE STRATEGY
1) ESTIMATE UNIVARIATE
VOLATILITY MODELS FOR ALL
COMMODITIES.
2) CONSTRUCT STANDARDIZED
RESIDUALS (returns divided by
conditional standard deviations)
3) ESTIMATE CORRELATIONS
BETWEEN STANDARDIZED
RESIDUALS WITH A SMALL
NUMBER OF PARAMETERS
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

TABLE 11 : D.C.C(Brent) UK Metals Commodities /Obs. 4821

Yearly

PLATINUM

GOLD

SILVER

COPPER

NICKEL

ALUMINIUM

LEMINDEX

1996

0.07855223

0.105723007

0.095580229

0.13844963

0.108174156

-0.025476933

0.066655779

1997

-0.021195475

0.042265175

0.016703092

-0.001028944

0.070684024

-0.027694296

-0.01784332

1998

0.038180071

0.139616604

0.056528383

0.152209546

0.141586205

0.176897924

0.203590036

1999

0.056103352

0.158292205

0.057270038

0.150829248

0.129345933

0.118757589

0.13867816

2000

0.064015683

0.067068025

0.017701088

0.060031376

0.045463339

-0.022806934

-0.008585885

2001

0.097483211

0.056683031

-0.005616984

0.006054753

0.023560388

0.040797819

0.037662285

2002

0.124595669

0.05815031

0.01971048

0.090142002

0.06825894

0.064638148

0.090778928

2003

0.06891501

0.093329176

0.026971226

0.092712217

-0.047773863

0.010882912

0.029528623

2004

0.142016067

0.163864841

0.078601561

0.179855376

0.132698273

0.169007663

0.110321499

2005

0.073900423

0.099699871

0.075535965

0.168550431

0.106979868

0.102455562

0.151017586

2006

0.235220856

0.301233985

0.184136756

0.212175027

0.231963458

0.239039168

0.266449004

2007

0.203097292

0.268739395

0.182178488

0.223825303

0.096703651

0.153330037

0.18862271

2008

0.296176704

0.384149664

0.271906726

0.335505048

0.309687641

0.434777522

0.452876137

2009

0.296977452

0.238571658

0.240305422

0.47819454

0.43168423

0.43430208

0.520813888

2010

0.36290046

0.290574239

0.305240593

0.473809934

0.459435635

0.428966838

0.499452446

2011

0.31273609

0.306130182

0.238793731

0.41295139

0.375680979

0.415271962

0.468337087

2012

0.326305552

0.303066518

0.233247206

0.432709322

0.311091263

0.346967915

0.420141614

2013

0.322377467

0.31996481

0.251537097

0.361394785

0.243082181

0.265513413

0.333711743

2014

0.092157292

0.142945954

0.118467158

0.179421644

-0.000707213

0.038480305

0.070204649

Av.Total

0.166869232

0.186319403

0.129726224

0.218304875

0.170399952

0.177058352

0.211705946

Av.Dev.

0.107456633

0.097039498

0.091530129

0.125290126

0.12313955

0.139518993

0.155772663

The equation for average deviation is: The description would be that the returns are the average of the absolute deviations of data points from their mean. Average Deviation is the measure of the
variability/volatility of data set.

Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

10

BEKK-GARCH Approach
The so-called BEKK model (named after Baba, Engle, Kraft and Kroner, 1990). Later was developed into BEKK-GARCH by Engle and Kroner (1995).

The spillover empirically specified by a bivariate VARGARCH (1,1) model that accommodates Brent oil price
returns and commodities returns of each commodity
lagged one period.

To clarify, ex: _12 denotes the spillover of volatility

originating from oil arena channelling to the
commodity arena.
Table 12: BEKK- GARCH Crude Oils, Bond, Foreign Exchange

Table 13: BEKK- GARCH - Metals

Obs. 4821/Oil

Platinum

Gold

Silver

Copper

Nickel

Aluminium

LEMINDEX

0.0008159
( 0.00028)
-0.0002136

0.00092
(0.00027)

0.00104
(0.000246)

-0.001031
(0.000315)

0.001005
(0.00027)

0.00094
(0.000246)

0.000837
(0.000333)
-0.000126
(0.000307)
0.00088
(0.00034)

-0.00037
(0.0005)
0.00131
(0.00045)

0.000777
(0.00053)
0.00142
(0.000199)

0.18089
(0.01879)
-0.00026
(0.00426)
-0.0194
(0.0204)
0.253819
(0.04529)
0.982726
(0.00349)
0.00040
(0.00087)
0.00657
(0.0047)

0.1812
(0.019)
0.010047
(0.00788)
0.0044
(0.01026)
0.22758
(0.03735)
0.98288
(0.00358)
-0.00066
(0.00123)
-0.00054
(0.00219)

0.18919
(0.01856)
-0.00083
(0.00848)
0.004528
(0.02140)
0.2316
(0.0187)
0.9814
(0.00349)
0.00032
(0.00217)
-0.0030
(0.00546)

-0.001116
(0.00088)
0.00205
(0.00036)
0.18497
(0.0167)

0.000287
(0.00050)
0.00123
(0.00018)
0.19038
(0.01837)

0.00029
(0.00044)
0.00107
(0.00017)
0.19031
(0.0194)

-0.0001
(0.01561)
0.015259
(0.0160)
0.20306
(0.02070)
0.9821
(0.0032)
0.000164
(0.00366)
-0.00463
(0.0045)

-0.00219
(0.0066)
0.00956
(0.020975)
0.19378
(0.01928)
0.98113
(0.00373)
0.00093
(0.00142)
-0.00366
(0.00532)

0.00199
(0.0060)
0.0053
(0.0283)
0.2113
(0.0239)
0.981374
(0.00374)
0.00005
(0.001317)
-0.00273
(0.0065)

0.96578
(0.011319)

0.97260
(0.008507)

0.968213
(0.00535)

0.97368
(0.00586)

0.97635

0.974068
(0.0060)

27799.5885

24739.3652

25660.85

23984.799

( 0.000631)
0.0012829
(0.000306)
0.185693

( 0.015628)
0.005917
(0.008466)
0.0019847
(0.0192802)
0.2729179
(0.0239831)
0.982176
(0.002941)
-0.0004023
(0.0017389)
0.001885

( 0.007066)
0.9597798

L.L

( 0.0068045)
26396.4798

( 0.0046)
26530.6339

26628.1892

NOTE: Entries in bold are significant at the 1% level, and in italic are significant at 5%, and in bold and italic are significant at 10%. The numbers
between (brackets) are standard deviation/error. The L.L is the log likelihood. The MV-GARCH(p,q) BEKK is estimated by BFGS.

Thursday, January 7, 2016

Obs. 4821/Oil

WTI

OPEC

AVRG13CRUDEOILS

UK10YRBOND

YUAN/POUND

-0.00131
(0.00076)

0.00203
(0.0005)

0.000716
(0.00033)

-0.001019
(0.00023)

0.0009488
(0.00030)

0.00396
(0.001478)

-0.00011
(0.00032)

0.000887
(0.00022)

0.0000156
(0.000124)

0.00013
(0.00016)

0.00146
(0.00307)

0.00000
(0.00013)

-0.00008
(0.0008)

0.0003032
(0.0000)

0.00045
(0.00009)

0.26714
(0.0223)

0.21086
(0.04477)

0.25354
(0.03744)

0.193211
(0.0169)

0.18542
(0.01735)

-0.1805
(0.03962)

-0.1711
(0.03082)

-0.02621
(0.03667)

-0.00209
(0.00208)

0.00372
(0.00363)

-0.16269
(0.03491)

-0.34588
(0.0373)

-0.42691
(0.0405)

0.03035
(0.07047)

0.0133
(0.04892)

0.44788
(0.041297)

-0.08288
(0.03671)

-0.1871
(0.0432)

0.16645
(0.017565)

0.160624
(0.01835)

0.92105
(0.01899)

0.95053
(0.02131)

0.93577
(0.01278)

0.9805
(0.0029)

0.982211
(0.00333)

0.1215
(0.0277)

0.04934
(0.0141)

0.0076
(0.0090)

0.00027
(0.00044)

-0.00051
(0.00070)

0.0767
(0.0214)

0.04659
(0.02699)

0.09949
(0.02529)

-0.00134
(0.0154)

-0.0077
(0.01133)

0.8441
(0.029)

0.91277
(0.0195)

0.9632
(0.01859)

0.9828
(0.00372)

0.9828
(0.00353)

L.L

25545.1807

27765.7836

29562.5721

323132.0088

30626.9936

NOTE: Entries in bold are significant at the 1% level, and in italic are significant at 5%, and in bold and italic are significant at 10%. The numbers between
(brackets) are standard deviation/error. The L.L is the log likelihood. The MV-GARCH(p,q) BEKK is estimated by BFGS.

Sultan Salem & Abhishek Kumar

11

Simple Linear (Model 1) & CAPM (Model 2) Using GARCH Application

Since ARCH was significant when tested, we

use GARCH for Linear

We also use CAPM Adapted for GARCH Application.

TABLE 17: BRENT Crude Oil (G)ARCH 1.1 with other Metal Commodities using CAPM model 2

TABLE 15: BRENT Crude Oil (G)ARCH 1.1 with Metal Commodities using linear model 1
Obs. 4821/Oil

Constant

(1)

(1)

Iteration
Convergen
ce

Platinum

2.19E-06
(2.75E-07)

0.083661
(0.003883)

0.909445
(0.004079)

15

14287.49

-5.925115

0.022155

2/03/2006

Gold

7.73E-07
(9.41E-08)

0.064252
(0.002102)

0.932424
(0.002419)

24

15671.67

-6.499346

0.023826

12/20/2005

1.87E-06
(3.16E-07)

0.058672
(0.002816)

0.939906
(0.002983)

11

Copper

2.79E-06
(4.15E-07)

0.056501
(0.003436)

0.933255
(0.003938)

13

Nickel

5.96E-06
(8.91E-07)

0.046733
(0.003017)

0.941035
(0.004078)

Aluminium

1.73E-06
(3.08E-07)

0.043211
(0.003374)

0.946862
(0.003907)

11

14354.72

-5.953004

0.033703

2/01/1996

LEMINDEX

1.19E-06
(2.28E-07)

0.046499
(0.003162)

0.947142
(0.003507)

15

14383.88

-5.965101

0.046876

2/02/2006

Silver

14

L.L

12662.18

13449.42

11854.81

A.I.C

RSquared

Break Points
(Bai-Perron
tests)

-5.250852

-5.577441

-4.915913

0.010058

0.048396

0.035059

Constant

Brent returns

Market Returns
(LMIINDEX)

(1) + (1)
(G)ARCH

L.L

R-squared

Iteration
Convergence

Break Points
(Bai-Perron tests)

Platinum

0.000115
(0.000152)

0.051708
(0.007191)

0.196329
(0.011375)

0.99217
(0.008198)

14405.57

0.067854

14

12/27/2005

Gold

2.37E-05
(0.000114)

0.036211
(0.005327)

0.190154
(0.007773)

0.992403
(0.005856)

15845.41

0.098345

27

11/16/2005

Silver

4.05E-05
(0.000215)

0.035117
(0.009617)

0.190576
(0.014905)

0.998488
(0.005517)

12710.67

0.039489

15

12/27/2005

Copper

2.73E-05
(6.90E-05)

-0.001269
(0.003175)

1.076676
(0.005080)

0.98664
(0.011236)

17949.09

0.796443

14

1/04/1999

Nickel

-0.000130
(0.000190)

0.013516
(0.009536)

1.097496
(0.013001)

0.986346
(0.008634)

13241.82

0.431101

15

10/14/1998

Aluminium

-0.000121
(9.26E-05)

-0.007870
(0.003996)

0.813778
(0.006384)

0.986227
(0.011032)

16840.10

0.607260

11

10/07/1999

1/11/2005

2/02/2006

5/26/2004

NOTE: Entries in bold are significant at the 1% level, and in italic are significant at 5%, and in bold and italic are significant at 10%. The
numbers between (brackets) are standard deviation/error. The L.L is the log likelihood. The GARCH(p,q) is estimated by BFGS.

Thursday, January 7, 2016

Obs. 4821/Oil

NOTE: Entries in bold are significant at the 1% level, and in italic are significant at 5%, and in bold and italic are significant at 10%. The numbers between
(brackets) are standard deviation/error. The L.L is the log likelihood. The GARCH(p,q) is estimated by BFGS.

Sultan Salem & Abhishek Kumar

12

Results
This paper has computed several correlation and volatility models, explicitly CCC, DCC,
BEKK and so forth between 1/1/1996 to 1/23/2014, for the commodities between
crude oil Brent and UK top six metals commodity arena mainly.
The estimated output were used to suggest that UK commodities seem to have
Dynamic rather than constant relationship with Brent Crude oil, and the volatility is
dynamic over time.
Moreover, the volatility is more significant during the global financial crisis rather than
Asian financial crisis and with a spillover effect in global financial crisis.
The structural breaks hints of no affect from the Asian financial crises which instigated
in 1997/8, as we can see the break points by Bai-Perron tests were mainly far from the
Asian financial crisis period, except in CAPM model for Nickel which points for the
10/14/1998 break point.
This motivate for a Markov Switching Regime being adapted to be Markov Switching
regime with DCC.
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

13

.15
.10
.05
.00
-.05
-.10
-.15
96

97

98

99

00

01

02

03

04

05

06

07

08

09

10

11

12

13

14

OILBREN RET

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Sultan Salem & Abhishek Kumar

14

Plus and Minus three Sigma

.100
.075
.050
.025
.000
-.025
-.050
-.075
-.100

96

97

98

99

00 01

02

03

04

05 06

07

08

09

10

11 12

13 14

3 * AVRGTOP6METALS VOL
AVRGTOP6METALS RET
-3 * AVRGTOP6METALS VOL
(Thanks to Prof. Lester Hunt for the comment that seemingly provided some kind of starting guide point.)
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

15

Plus and Minus three Sigma

.100
.075
.050
.025
.000
-.025
-.050
-.075
-.100

96

97

98

99

00 01

02

03

04

05 06

07

08

09

10

11 12

13 14

3 * AVRGTOP6METALS VOL
AVRGTOP6METALS RET
-3 * AVRGTOP6METALS VOL
(Thanks to Prof. Lester Hunt for the comment that seemingly provided some kind of starting guide point.)
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

16

Plus and Minus three Sigma

.100
.075
.050
.025
.000
-.025
-.050
-.075
-.100

96

97

98

99

00 01

02

03

04

05 06

07

08

09

10

11 12

13 14

3 * AVRGTOP6METALS VOL
AVRGTOP6METALS RET
-3 * AVRGTOP6METALS VOL
(Thanks to Prof. Lester Hunt for the comment that seemingly provided some kind of starting guide point.)
Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

17

Thank You

Thursday, January 7, 2016

Sultan Salem & Abhishek Kumar

18

Thank you for listening

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