Do seasonality, break and spillover effects explain commodity price volatility

Abstract

Purpose The purpose of this paper is to understand the volatility in commodity futures and spot markets. The study starts with a few questions: first, the effect of seasonality on the volatility is studied. Thereafter, the presence of structural breaks in the variance is identified. At last the seasonality, structural shifts and spillover effects are examined together to find out their effects on volatility. Design/methodology/approach The methodology heavily employs econometric tools and techniques. The monthly seasonal dummies are incorporated to identify the effects of seasonality on volatility. Then, the presence of break in volatility is tested by cumulative sum of squares (CUSUM test), followed by generalized autoregressive conditional heteroscedastictity and EGARCH models are measured by including seasonal dummies, break dummies and the residuals of other market in the variance equation to determine spillover effects. Findings It is found that the effects of seasonality on volatility cannot be ignored as the effects are significant. The presence of asymmetry is detected in all the commodities. The presence of seasonality and structural breaks in the variance equation are statistically able to reduce the volatility but the magnitude is very negligible with an exception in cumin futures markets. Bi-directional volatility spillover between futures and spot markets is observed in all the commodities and the effect of spillover is more from spot markets to the futures markets. Research limitations/implications This study is limited to a few agro commodities which are well traded. This study could have been extended to the other thinly traded commodities. This study has also taken only near month futures contracts as it contains more information but the same could have been studied by taking far month contracts also. Originality/value The present study attempted to understand the conjugated effects of seasonality, structural breaks and spillover on volatility of commodity markets which is not apparent in the previous studies. This study has also employed methodological rigor to identify the breaks in the variance equation. In addition to this it has also investigated whether Indian commodity futures markets are informationally more efficient than the spot markets.

Price discovery and volatility spillover: an empirical evidence from spot and futures agricultural commodity markets in India

“…The results also show that price discovery exists in Chinese steel futures markets. Spillover effect between futures and spot markets was examined for pepper, cumin, soy oil and guar seed in Indian context, and volatility comovements were found to be positive and significant (Maitra D., 2018).…”

Wavelet-based analysis of guar futures in India: did we kill the golden goose?

“…Nath and Lingareddy (2008) and Gupta et al (2018) studied the volatility of Indian agrarian commodities and recognized that speculation and volatility in the futures market have destabilization impact on the spot market. Manogna and Mishra (2020), Maitra (2018) highlighted significant volatility spillover for GS futures markets. Ahmad and Sehgal (2015) identified the destabilizing effect of commodity futures on the underlying spot market for chana, chilli and pepper.…”

Does Seasonality and Volatility Affect the Price Discovery of Agricultural Commodities? A Systematic Literature Review Paper on the Indian Commodity Market

“…A spike in volatility, implying an increase in risk. Volatility in agricultural commodities cannot be studied in isolation because of the seasonality and cyclical fluctuation in relation (49).…”

“…Seasonality in commodity markets is generally caused by a supply-demand imbalance. (49). This systematic literature review paper tries to study the volatility and seasonality that affect the price discovery of the agricultural commodities in the spot and the futures market and draw a conclusion on the price discovery process.…”