Modelling the volatility of commodities prices using a stochastic volatility model with random level shifts

Dennis Alvaro, Ángel Guillén and Gabriel Rodríguez
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Dennis Alvaro: Pontificia Universidad Católica del Perú
Ángel Guillén: Pontificia Universidad Católica del Perú

Review of World Economics (Weltwirtschaftliches Archiv), 2017, vol. 153, issue 1, No 3, 103 pages

Abstract: Abstract We use the approach of Qu and Perron (Econom J 16(3):309–339, 2013) for the modeling and inference of volatility of a set of commodity prices in the presence of random level shifts of unknown timing, magnitude and frequency. Our approach contributes to the study of commodities in several aspects. First, we test for the presence of a genuine long-memory process in the volatility of commodities. Second, we determine that the random level shifts are certainly the main source of variation in the commodity price volatility. Finally, we estimate the volatility and its components as latent variables, thereby making it possible to evaluate their level of correlation with macroeconomic variables in small open economies such as Latin-American countries where the dependence on commodity price volatility is high. We use six commodity series: agriculture, livestock, gold, oil, industrial metals and a general commodity index. All series cover the period from January 1983 until December 2013 in daily frequency. The results show that although the occurrence of a level shift is rare, (about once every 1.5 or 1.8 years), this component clearly contributes most to the variation in the volatility. Furthermore, isolating the level shift component from the overall volatility indicates a strong relationship of this component with a set of business cycle indicators of several Latin American countries.

Keywords: Stochastic volatility; State-space models; Bayesian inference; Random level shifts; Commodity prices long memory (search for similar items in EconPapers)
JEL-codes: C22 C52 G12 (search for similar items in EconPapers)
Date: 2017
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Working Paper: Modelling the Volatility of Commodities Prices using a Stochastic Volatility Model with Random Level Shifts (2016)
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DOI: 10.1007/s10290-016-0271-z

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