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Leverage effects and stochastic volatility in spot oil returns: A Bayesian approach with VaR and CVaR applications

Liyuan Chen (), Paola Zerilli and Christopher Baum ()

No 953, Boston College Working Papers in Economics from Boston College Department of Economics

Abstract: The crude oil markets have been quite volatile and risky in the past few decades due to the large fluctuations of oil prices. We contribute to the current debate by testing for the existence of the leverage effect when considering daily spot returns in the WTI and Brent crude oil markets and by studying the direct impact of the leverage effect on measures of risk such as VaR and CVaR. More specifically, we model spot crude oil returns using Stochastic Volatility (SV) models with various distributions of the errors. We find that the introduction of the leverage effect in the traditional SV model with Normally distributed errors is capable of adequately estimating risk for conservative oil suppliers in both the WTI and Brent markets while it tends to overestimate risk for more speculative oil suppliers. Our results also show that the choice of financial regulators, both on the supply and on the demand side, would not be affected by the introduction of leverage. Focusing instead on firm’s internal risk management, our results show that the introduction of leverage would be useful for firms who are on the demand side for oil, who use VaR for risk management and who are particularly worried about the magnitude of the losses exceeding VaR while wanting to minimize the opportunity cost of capital. Using the same logic, firms who are on the supply side would be better off not considering the leverage effect.

Keywords: Value-at-Risk; Conditional Value-at-Risk; Asymmetric Laplace distribution; Stochastic volatility model; Bayesian Markov Chain Monte Carlo; leverage effect (search for similar items in EconPapers)
JEL-codes: C11 C58 G17 G32 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ene, nep-knm, nep-ore and nep-rmg
Date: 2018-01-28
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