Modelling Petroleum Future Price Volatility: Analysing Asymmetry and Persistency of Shocks

Understanding the nature of volatility in commodity prices warrants adequate attention because such volatility is likely to lead to increased production, search and opportunity costs, as well as accelerate uncertainty and risk, contributing to a slowdown of economic activities. This study examines the asymmetry and persistency in the volatility of a set of petroleum future price returns—namely crude oil, heating oil, gasoline, natural gas and propane—within the framework of a set of non‐linear generalized autoregressive conditional heteroscedasticity (GARCH)‐type models. Specifically, we employ threshold GARCH, exponential GARCH, asymmetric power ARCH and component GARCH models using daily data over the period 1995–2010. The study reveals the following: over the full sample period of 1995–2010, all future price returns show persistent and asymmetric effects of shocks to the volatility but the level of persistency and degree of asymmetry differ product to product; over the subsample 1995–2001, persistency and asymmetry are evident for all series with the exception of gasoline future price returns; the recent subsample of 2002–2010 shows mixed evidence and all series show persistent effects of shocks to the volatility while asymmetry is supported in crude oil and propane only; the study also concludes that based on forecasting performance, no single model can be recommended but different models should be used based on the time periods involved and the nature of petroleum products. These findings also imply that in the presence of asymmetric and persistent volatility, policy measures should be taken to accommodate long lasting effects of shocks to the volatility. And since negative effects of shocks are not fully compensated by positive shocks, counter‐cyclical policies should be taken to counter the pessimistic and optimistic overreactions of businesses to ensure a stable business environment.