Correlation between Shanghai crude oil futures, stock, foreign exchange, and gold markets: a GARCH-vine-copula method

ABSTRACT

The relationship between markets has always been a topic of heated debate among scholars from various countries. One of the most important concerns is the need to model the relationships between the crude oil market and other markets. Based on daily return observations from 2018 to 2019, we apply a GARCH-vine-copula approach to probe the linkage between Shanghai crude oil futures, stock, foreign exchange, and gold markets. We find that obvious tail dependencies do exist between these markets. And the crude oil futures market occupies a dominant position. Moreover, when the Shanghai crude oil futures market is taken as the known condition, the links between different markets reduce to some extent. Finally, value at risk results denote that the risk of the Shanghai crude oil futures market is relatively high, but portfolio investment can effectively reduce the risk. Moreover, the model fitting results at different confidence levels have passed the Kupiec backtest, indicating that the model in this paper fits the relationship between these markets well.

KEYWORDS:

• Shanghai crude oil futures market
• GARCH-vine-copula model
• Value at Risk
• Backtesting

JEL CLASSIFICATION:

• G14
• C51

Acknowledgments

The authors acknowledge the constructive comments from the Editor and anonymous reviewers. Certainly, all remaining errors are our own. Chaohua He acknowledges the financial support from “the Fundamental Research Funds for the Central Universities” in UIBE (Grant No.: 18YB12).

Disclosure statement

No potential conflict of interest was reported by the authors.

Notes

¹ www.fia.org and the largest one in the Asia-Pacific region (Yang et al. 2020). However, different from these two futures, Shanghai crude oil futures are RMB-denominated derivatives based mainly on relatively heavy and sour crude oils, which can better satisfy the demand of the Asian-Pacific region.²

² As the world’s largest importer of crude oil, China mainly imports medium-quality oils with medium- or high- sulphur, which are relatively heavy and sour in terms of EIA’s (US Energy Information Administration) definition: crude oil with less (more) than 1% sulphur is sweet (sour) and that with API gravity less than 25 (more than 35) degrees is heavy (light). So do other major Asian-Pacific countries such as Japan and South Korea. In harmony with these Asian-Pacific markets, Shanghai crude oil futures are dominated in RMB and are based on relatively heavy and sour crude oils with API 20–34 and sulphur 0.5–2% or greater. In contrast, all WTI and Brent oil futures are USD dominated and are derived from light and sweet crude oils. Along with the increasing influence of RMB, oil futures being RMB dominated facilitates not merely the Chinese crude oil market, but the other Asian-Pacific markets as well due to similar demand preference. In addition, Shanghai crude oil futures can be able to provide a more reasonable pricing benchmark and risk management instrument for crude oil trade in the Asian-Pacific region. Therefore, Shanghai crude oil futures, in comparison to WTI and Brent peers, better satisfy the needs of the Asian-Pacific region. This commodity is an essential complement to WTI and Brent and a significant strategy for the internationalization of RMB (Ji and Zhang 2019b; Yang et al. 2020).

³ According to Davidson and MacKinnon (1993), ${\hat{\theta }}_{ML}$ is asymptotically normal and $\sqrt{T}({\hat{\theta }}_{ML}-{\theta }_0)\to N(0,I^{-1}({\theta }_0))$, where $I^{-1}({\theta }_0)$ denotes the Fisher information matrix.

Additional information

Funding

This work was supported by the ``the Fundamental Research Funds for the Central Universities’’ in UIBE [18YB12].