Dynamics of the Forward Curve and Volatility of Energy Futures Prices

Abstract

The shapes of forward curves of energy commodities are believed to contain information on the volatility of futures prices for these commodities. The slope of the forward curve not only reflects temporal supply and demand conditions, but also the relationship between current and expected market conditions. However, no empirical investigation exists in the literature on whether utilising information on the slopes of the forward curves of energy commodities can improve one"s ability to capture the dynamics of the volatility of the futures prices of these commodities. The aim of this study is to undertake such an investigation. Daily energy futures prices traded on the New York Mercantile Exchange (NYMEX) over the period January 1997 to December 2006 are used to estimate the parameters of an augmented transition EGARCH model that allows for changes in the model"s parameters based on the forward curve. The forecasting performance of the model is compared to that of other models in predicting the volatility of energy futures prices over the period January 2007 to December 2008. The results provide strong support in favour of a convex relationship between the volatility of energy futures prices and the forward curve.

Market conditions, trader types and price–volume relation in energy futures markets

“…Moreover, positive and significant coefficients of lagged squared slope, , in all models and across all maturities reveal a convex relationship between the slope of forward curve and volatility. This is in line with previous literature (Kogan et al, 2009, andAlizadeh andTalley, 2009) and implies that the steeper the slope of the forward curve the higher is the volatility of futures prices.…”

Oil prices, US inflation, US money supply and the US dollar

“…The opposite impact, i.e. positive shocks increasing the conditional variance by less than negative shocks, is found in Alizadeh and Talley (2009). Kuper (2002) does not detect any asymmetry in the conditional variance, and Olowe (2009) does not reject symmetry in his EGARCH model.…”