The economic impact of daily volatility persistence on energy markets

Abstract

This study examines the role of daily volatility persistence in transmitting information from macro-economy in the volatility of energy markets. In crude oil and natural gas markets, macro-economic factors, such as the VIX, the credit spread and the Baltic exchange dirty index, impact volatility, and this impact is channeled via the volatility persistence. Further, the impact of returns and variances is primarily transmitted to volatility via the daily volatility persistence. The dependence of volatility persistence on market and macro-economic conditions is termed conditional volatility persistence (CVP). The variation in daily CVP is economically significant, contributing up to 18% of future volatility and accounting for 29% of the model's explanatory power. Inclusion of the CVP in the model significantly improves volatility forecasts. Based on the utility benefits of volatility forecasts, the CVP adjusted volatility models provide up to 160 bps benefit to investors compared to the HAR models, even after accounting for transaction costs and varying trading speeds.