Modelling food price volatility : estimation and risk analysis

Abstract

Over the last ten years approximately, global food markets underwent a strong period of marked as well as continuous volatility. Since 2006 and after the relevant food prices inflation that led to unseen highs between 2006 and 2008, market instability has been particularly intensive. Whereas during the second half of 2008 prices tended to decline again, and market turbulences re-immerged in 2010 as well as 2011. Volatility in food prices and the correlation and interdependence between different agriculture commodities had been the interest of many researchers. In this project, we conducta multivariate GARCH model using their versions the Vector Heteroskedastic (VECH) and the Constant Correlation models to study the conditional variance and the correlation between five assets: sugar, oats, cotton, cocoas and corn. In addition to that, we highlight the impact of the financial crisis on the correlation between those five assets. We find that the models fit very well this interdependence between these markets. Then, we uncover through those models that the correlation was strongly higher after the financial crisis of 2007-2009 and that their variances and covariances become more persistent with more peaks and fluctuations. Our findings should be helpful to investors of commodities, futures contracts and risk managers who build their investment strategies based on the dynamics of these assets. Further, our results should be useful to all the investments vehicles created such as new mutual funds, hedge funds and more sophisticated assets, whose performance depends on those commodities.