The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

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IHS Economics Series Working Paper 73

October 1999

The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

Adusei Jumah

Robert M. Kunst

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Impressum Author(s):

Adusei Jumah, Robert M. Kunst Title:

The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

ISSN: Unspecified

1999 Institut für Höhere Studien - Institute for Advanced Studies (IHS) Josefstädter Straße 39, A-1080 Wien

E-Mail: o ce@ihs.ac.at ﬃ Web: ww w .ihs.ac. a t

All IHS Working Papers are available online: http://irihs. ihs. ac.at/view/ihs_series/

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Institut für Höhere Studien (IHS), Wien Institute for Advanced Studies, Vienna

Reihe Ökonomie / Economics Series No. 73

The Effects of Dollar/Sterling Exchange Rate

Volatility on Futures Markets for Coffee and

Cocoa

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The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

Adusei Jumah, Robert M. Kunst

Reihe Ökonomie / Economics Series No. 73

October 1999

Institut für Höhere Studien Stumpergasse 56, A -1060 Wien Fax: +43/1/599 91-163

Adusei Jumah

Phone: +43/1/599 91-142 E-mail: jumah@ihs.ac.at

Robert M. Kunst

Phone: +43/1/599 91-255

E-mail: kunst@ihs.ac.at

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The Institute for Advanced Studies in Vienna is an independent center of postgraduate training and research in the social sciences. The Economics Series presents research carried out at the Department of Economics and Finance of the Institute. Department members, guests, visitors, and other researchers are invited to submit manuscripts for possible inclusion in the series. The submissions are subjected to an internal refereeing process.

Editorial Board Editor:

Robert M. Kunst (Econometrics)

Associate Editors:

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Abstract

The paper investigates the extent to which the dollar/sterling exchange rate fluctuations affect coffee and cocoa futures prices on the London LIFFE and the New York CSCE by means of multivariate GARCH models – under the assumption that traders in perfectly competitive markets have equal access to all available information on changes in weather and in global demand and supply conditions. In three out of the four investigated cases, exchange rate posed as a main source of risk for the commodity futures price. The significance and form of volatility spill-over effects of a bilateral exchange rate are shown to be specific for commodity and market. A forecasting comparison on the basis of the identified models suggests that possible gains in prediction accuracy may be small.

Keywords

Commodity markets, multivariate GARCH models, exchange rates, volatility, forecasting

JEL Classifications

C32, C53, G15, Q14

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Comments

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1. Introduction 1

2. Coffee and cocoa markets and their exchange rate linkages 3

3. Methodology 5

3.1 Bivariate ARCH models 5 3.2 Data characteristics 8

4. Empirical results 14

4.1 Model estimation 14

4.1.1 Cocoa futures: London and New York 14 4.1.2 Cocoa and exchange rates 16

4.1.3 Coffee futures: London and New York 18 4.1.4 Coffee and exchange rates 18

4.2 Forecasting 21

5. Summary and conclusion 25

References 26

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(16)

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(17)

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(18)

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(22)

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(23)

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(25)

Iru wkh Qhz \run frfrd ixwxuhv +vhh Wdeoh 7,/ wkh vhfrqg idfwru wxuqhg rxw wr eh lqvljqlfdqw dowrjhwkhu dqg zdv wkhuhiruh rplwwhg lq rughu wr ryhufrph wkh hqvxlqj frqyhujhqfh sureohpv1 Wkh frfrd ixwxuhv sulfh vhulhv jhqhudwhv d vpdoo exw vwdwlvwlfdoo| vljqlfdqw dxwrqrprxv yrodwlolw| wkdw/ e| frqvwuxfwlrq/

lq xhqfhv erwk yduldeohv1 Krzhyhu/ wklv hhfw lv frpsdudwlyho| vpdoo dqg vkrxog eh lqwhusuhwhg zlwk fduh1 Wkh jhqhudo slfwxuh wkdw lv jlyhq e| wkh Orqgrq vhulhv lv uhsurgxfhg lq wklv wklug h{shulphqw= wkh h{fkdqjh udwh lv h{rjhqrxv iru phdqv dqg yduldqfhv/ dqg wkh yrodwlolw| lq frfrd sulfhv lv pdlqo| h{sodlqhg e| wkh lqqrydwlrqv ri wkh h{fkdqjh udwh vhulhv1

Wdeoh 7= Elyduldwh prgho iru Qhz \run frfrd ixwxuhv dqg h{fkdqjh udwh1 prgho hvwlpdwhg whfkqlfdo

sdudphwhu |ydoxh

> 0313335 03144

> ₂ 313338 3186

w 315<< :138

w 2 31559 9174

w ₂ 3136: 418<

w 22 31787 44138

f ^e S :16;: S 77145

f ^e S ₂ 031675 , _S 041::

f ^e S 22 41354 S 2 6514:

4 514:9 96164

f ² @ 31335 @ 3167

f ² @ 2 0313:: , @ 06179

f ² @ 22 619:6

Qrwh= Vhh Wdeoh 51

(26)

71416 Frhh ixwxuhv= Orqgrq dqg Qhz \run

Iru wkh frhh ixwxuhv sulfhv zh xvh wkh urexvwd txdolw| lq Orqgrq dqg dudelfd txdolw| lq Qhz \run/ dv wkhvh txdolwlhv duh wkh prvw uhsuhvhqwdwlyh iru wkh wzr frpprglw| h{fkdqjhv1 Lq wkh qrwdwlrq ri +7,/ j | ' E{ L} R u| c { L} R | / khqfh wkh uvw yduldeoh lv wkh +orjdulwkplf jurzwk udwh ri wkh, Orqgrq sulfh1 Iru wkh vwdwlvwlfdo uhvxowv/ vhh Wdeoh 81 Djdlq/ wkh lqwhufhsw yhfwru lv lqvljqli0 lfdqw dqg wklv frqupv wkh ylvxdo lpsuhvvlrq1 Dw ohdvw wzr ri wkh prylqj0 dyhudjh frh!flhqwv duh vljqlfdqw dqg ghprqvwudwh wkh vxevwdqwldo vkruw0uxq vhuldo fruuhodwlrq lq uhwxuqv1 Udqn uhvwulfwlrqv fdq eh irxqg/ krzhyhu/ lq wkh DUFK idfwruv1 Wkh uvw idfwru pdwul{ dsshduv wr ghshqg rq 0 ² _|3c

rqo|/ l1h1/ rq wkh lqqrydwlrqv ri wkh Orqgrq ixwxuhv pdunhw1 Wkh vhfrqg idf0 wru pdwul{ dovr kdv udqn rqh dqg ghvfulehv d vhfrqg idfwru ri wkh irup EK 0 _|3c n K ₂ 0 _|3c2 ² wkdw ghshqgv rq erwk lqqrydwlrqv exw djdlq jlyhv pruh zhljkw wr wkh Orqgrq pdunhw1 Wkh odujh urwdwlrq sdudphwhu ri 41476 vkrzv wkdw wkh wzr DUFK idfwruv lq xhqfh wkh yrodwlolw| lq Orqgrq dv zhoo dv lq Qhz \run dqg dovr fdxvh qrq0wulyldo hhfwv lq wkh fryduldqfh ehwzhhq wkh pdunhwv1

71417 Frhh dqg h{fkdqjh udwhv

Dv lq wkh fdvh ri wkh frfrd sulfhv/ zh dovr hvwlpdwhg elyduldwh DUFK prghov iru wkh frhh sulfh vhulhv dqg wkh fxuuhqf| h{fkdqjh udwh vhulhv1

Hvwlpdwlrq ri ixoo| sdudphwhul}hg vwuxfwxuhv |lhoghg ydulrxv sdudphwhu hvwlpdwhv zlwk yhu| orz vljqlfdqfh1 Diwhu holplqdwlqj wkh lqvljqlfdqw sd0 udphwhuv iurp wkh DUFK sduw ri wkh prgho/ zh rewdlqhg d vlpsolhg prgho iru wkh Orqgrq ixwxuhv vhulhv1 Wklv prgho lv vxppdul}hg lq Wdeoh 91

Wkh uvw DUFK idfwru pdwul{ lv vlqjxodu dqg ghshqgv rq d olqhdu frpelqdwlrq ri fxuuhqf| h{fkdqjh dqg frpprglw| sulfh vkrfnv1 Wkh vhfrqg DUFK idfwru lv wkh h{fkdqjh udwh yrodwlolw|1 Wkh urwdwlrq sdudphwhu zdv lqvljqlfdqw dqg zdv wkhuhiruh rplwwhg1 Wkhuhiruh/ wkh uvw idfwru uhsuhvhqwv d cmrlqw* idfwru wkdw ghwhuplqhv wkh ulvn lq wkh sulfh vhulhv/ zkhuhdv wkh vhf0 rqg idfwru lv d sxuh fxuuhqf|0ulvn idfwru wkdw/ lqghshqghqwo|/ ghwhuplqhv wkh yrodwlolw| ri wkh h{fkdqjh udwh1 Qrwh wkdw wkh hqwulhv ri wkh pdwul{ duh ri d pxfk vpdoohu vfdoh wkdq wkh DUFK idfwruv/ zklfk jlyhv d grplqdqw uroh wr wlph0fkdqjlqj ulvn1

D frpsdudeoh h{shulphqw iru wkh Qhz \run ixwxuhv vhulhv jdyh txdolwd0

wlyho| vlplodu uhvxowv/ zklfk duh vxppdul}hg lq Wdeoh :1 Fxuuhqf| h{fkdqjh

(27)

Wdeoh 8= Elyduldwh prgho iru Orqgrq dqg Qhz \run frhh ixwxuhv1 prgho hvwlpdwhg whfkqlfdo

sdudphwhu |ydoxh

> 0313355 04135

> ₂ 0313348 031:4

w 314;< :135

w ₂ 0313;9 06153

w 2 3137< 41;5

w 22 31368 4156

f ² S 51736 S 5:1;4

f ² S 2 31374 , S ;184

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4 41476 6<144

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@ 2 031364 , @ 04164

@ ₂₂ 31335 @ ₂ 319<

K 31633 K 4;176

K 2 03143< , K 045157 K ₂₂ 31373 K ₂ 031:<

Qrwh= Vhh Wdeoh 51

(28)

Wdeoh 9= Elyduldwh prgho iru Orqgrq frhh ixwxuhv dqg h{fkdqjh udwh1 prgho hvwlpdwhg whfkqlfdo

sdudphwhu |ydoxh

> 031335< 04156

> ₂ 0313334 313;

w 31478 6156

w 2 031338 0314;

w 2 031347 03199

w 22 31763 43173

f ^e S 8166; S 581;7

f ^e S 2 31795 , S 41<5

f ^e S 22 41486 S 2 6514:

@ 319<8 @ 57136

@ 2 3159< , @ 4415:

@ 22 31437

K 313

K ₂ 313 , _K 044196

K 22 31447

Qrwh= Vhh Wdeoh 51

(29)

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Wdeoh := Elyduldwh prgho iru Qhz \run frhh ixwxuhv dqg h{fkdqjh udwh1 prgho hvwlpdwhg whfkqlfdo

sdudphwhu |ydoxh

> 0313353 031;5

> ₂ 0313334 3145

w 31378 4188

w 2 31469 71:9

w 2 31345 318:

w 22 3174< 47167

f ^e S 91773 S 5:1<4

f ^e S 2 3155; , S 31<7

f ^e S 22 41454 S 2 651<<

@ 318<< @ 631:6

@ ₂ 313

@ 22 313

K 313

K ₂ 313 , _K 046147

K 22 31475 Qrwh= Vhh Wdeoh 51

715 Iruhfdvwlqj

Wkh prghov iru wkh ydulrxv frpprglw| sulfhv duh frpsduhg dffruglqj wr

suhglfwlrq dffxudf|1 D iruhfdvwhu ri djulfxowxudo frpprglw| sulfhv lv dvvxphg

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iruhfdvwhu*v wdujhw lv zhoo uhsuhvhqwhg e| dq hvwlpdwh ri wkh frqglwlrqdo phdq

(30)

ri wkh yduldeoh E E% |n mL | dqg e| wkh sulp du| suhglfwlrq huuru

e |n| ' E E% |n mL | % | +8,

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sulfh1 Yrodwlolw| lq wklv vhulhv pdlqo| ghshqgv rq wkh Orqgrq pdunhw dqg

dovr rq wkh h{fkdqjh udwh1 Zh duh wkhuhiruh ohg wr h{shfw wkdw wkh h{fkdqjh

(31)

Wdeoh ;= Suhglfwlrq huuruv iru wkh frhh ixwxuhv sulfhv edvhg rq elyduldwh PDDUFK prghov1

, ₂ Ee , Ee , ₂ E0 , E0 Orqgrq

elyduldwh . h{fkdqjh udwh/ uhvwulfwhg 49143 61486 2.bD ^W 41763 elyduldwh . Qhz \run eHH ^W fS ^W 51;7< 41684 elyduldwh . Qhz \run/ uhvwulfwhg 471<8 6139; 51;58 D ^W

xqlyduldwh 49135 6147: 51;99 41758

Qhz \run

elyduldwh . h{fkdqjh udwh 461<7 61447 418;9 4136;

elyduldwh . Orqgrq 49138 6168< 6139; 4169;

xqlyduldwh He ^W fbD ^W Deb ^W f2S ^W

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Wdeoh <= Suhglfwlrq huuruv iru wkh frfrd ixwxuhv sulfhv edvhg rq elyduldwh PDDUFK prghov1

, 2 Ee , Ee , 2 E0 , E0 Orqgrq

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xqlyduldwh 61674 41764 31595 31797

Qhz \run

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xqlyduldwh 71534 418:6 41365 31<96

Qrwh= Vhh Wdeoh ;1

(32)

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wkh iruphu rqh lv qrw vxssruwhg1 Wkh elyduldwh prgho iru wkh Orqgrq dqg Qhz \run frhh ixwxuhv jhqhudwhv iruhfdvw idloxuh rq vrph rffdvlrqv wkdw wudqvihuv lqwr dq lqihulru dyhudjh phdqv iruhfdvw dqg ixuwkhu lqwr d edg ulvn iruhfdvw1 Wkh xqlyduldwh prgho grplqdwhv iru doo fulwhuld1

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\run1 Wkh lqqrydwlrqv rq wkh Orqgrq pdunhw h{huw d vxevwdqwldo lq xhqfh

rq wkh Qhz \run pdunhw zlwk d odj ri durxqg rqh prqwk/ dqg ljqrulqj wklv

hhfw |lhogv edg suhglfwlrqv1 Iru wkh elyduldwh prghov/ wkh udqnlqj lv glhu0

(33)

hqw iru wkh wzr pdunhwv1 Lq Orqgrq/ d elyduldwh prgho zlwk wkh wzr ixwxuhv sulfhv grplqdwhv wkh h{fkdqjh udwh prgho1 Wkh h{fkdqjh udwh prgho lv rqo|

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udwh yrodwlolw| dhfwv frfrd ixwxuhv sulfhv rq wkh OLIIH dqg FVFH1 Wkh

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Orqgrq pdunhw lq xhqfhv wkh sulfh ulvn rq wkh Qhz \run pdunhw1 D vlplodu

phfkdqlvp dsshduv wr eh dw zrun dfurvv ixwxuhv sulfhv iru frhh lq Orqgrq

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(34)

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Institut für Höhere Studien Institute for Advanced Studies Stumpergasse 56

A-1060 Vienna Austria

Phone: +43-1-599 91-145

Fax: +43-1-599 91-163

The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

IHS Economics Series Working Paper 73

October 1999

The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

Adusei Jumah

Robert M. Kunst

Impressum Author(s):

Adusei Jumah, Robert M. Kunst Title:

The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

ISSN: Unspecified

1999 Institut für Höhere Studien - Institute for Advanced Studies (IHS) Josefstädter Straße 39, A-1080 Wien

E-Mail: o ce@ihs.ac.at ﬃ Web: ww w .ihs.ac. a t

All IHS Working Papers are available online: http://irihs. ihs. ac.at/view/ihs_series/

Institut für Höhere Studien (IHS), Wien Institute for Advanced Studies, Vienna

Reihe Ökonomie / Economics Series No. 73

The Effects of Dollar/Sterling Exchange Rate

Volatility on Futures Markets for Coffee and

Cocoa

The Effects of Dollar/Sterling Exchange Rate Volatility on Futures Markets for Coffee and Cocoa

Adusei Jumah, Robert M. Kunst

Reihe Ökonomie / Economics Series No. 73

October 1999

Institut für Höhere Studien Stumpergasse 56, A -1060 Wien Fax: +43/1/599 91-163

Adusei Jumah

Phone: +43/1/599 91-142 E-mail: jumah@ihs.ac.at

Robert M. Kunst

Phone: +43/1/599 91-255

E-mail: kunst@ihs.ac.at

Editorial Board Editor:

Robert M. Kunst (Econometrics)

Associate Editors:

Abstract

Keywords

Commodity markets, multivariate GARCH models, exchange rates, volatility, forecasting

JEL Classifications

C32, C53, G15, Q14

Comments

Contents

1. Introduction 1

2. Coffee and cocoa markets and their exchange rate linkages 3

3. Methodology 5

3.1 Bivariate ARCH models 5 3.2 Data characteristics 8

4. Empirical results 14

4.1 Model estimation 14

4.1.1 Cocoa futures: London and New York 14 4.1.2 Cocoa and exchange rates 16

4.1.3 Coffee futures: London and New York 18 4.1.4 Coffee and exchange rates 18

4.2 Forecasting 21

5. Summary and conclusion 25

References 26

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