City Research Online

Abstract

The margin between the price of crude oil and one or more of its refined products, known as the crack spread, is a key risk measure in the energy trading industry. Effective forecasts of crack spread returns require modelling the co-movements of crude oil and refined product prices. To this end, in this paper we re-examine the relationship between parameter instability in energy commodity returns correlations and macroeconomic fundamentals using a new correlation component model dubbed the Regime Switching DCC-MIDAS, which distinguishes regime switches in the short and long-run correlations. Breaks in the secular component are associated with low-frequency macroeconomic fundamentals, while short-run correlations are characterized by abrupt breaks linked to market constraints. Our results reveal the benefits of our specification for Value-at-Risk and portfolio optimization in terms of forecasting performance at medium and long horizons and in times of intense market instability, such as the recent pandemic crisis.

Publication Type:	Article
Additional Information:	© 2023 Bayes Business School – City, University of London (U.K.)
Subjects:	H Social Sciences > HB Economic Theory H Social Sciences > HG Finance
Departments:	School of Policy & Global Affairs > Economics Bayes Business School > Finance

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