Return and volatility transmission between China's and international crude oil futures markets: A first look

• Author: Yinggang Zhou,Jian Yang
• Published date: 01 June 2020
• Date: 01 June 2020
• DOI: http://doi.org/10.1002/fut.22103

J Futures Markets. 2020;40:860–884.wileyonlinelibrary.com/journal/fut860

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© 2020 Wiley Periodicals, Inc.

Received: 16 November 2018

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Accepted: 19 January 2020

DOI: 10.1002/fut.22103

RESEARCH ARTICLE

Return and volatility transmission between China’s and

international crude oil futures markets: A first look

Jian Yang

1

|Yinggang Zhou

2,3

1

J.P. Morgan Center for Commodities, The

Business School, University of Colorado

Denver, Denver, Colorado

2

Center for Macroeconomic Research,

Department of Finance, School of

Economics (SOE), Xiamen University,

Xiamen, China

3

Wang Yanan Institute for Studies in

Economics (WISE), Xiamen University,

Xiamen, China

Correspondence

Yinggang Zhou, Center for

Macroeconomic Research, Department of

Finance, School of Economics, Xiamen

University, Xiamen 361005, China;

Wang Yanan Institute for Studies in

Economics, A403 Economics Building,

Xiamen University, Xiamen 361005, China.

Email: yinggang.zhou@gmail.com

Funding information

National Natural Science Foundation of

China, Grant/Award Numbers: 71571106,

71871195, 71988101

Abstract

We examine return and volatility transmission between the newly established

crude oil futures in China and international major crude oil futures markets

using intraday data. For the first time, we document evidence for cointegration

relationships among these oil futures markets. Both China’s and Oman’s oil

futures markets react to deviations from their long‐run equilibrium with West

Texas Intermediate and Brent oil futures. There is also new evidence for

asymmetric volatilities and correlations across these oil futures markets. Fur-

thermore, the Chinese oil futures have stronger linkages with the international

major futures markets than Oman futures.

KEYWORDS

asymmetry, cointegration, conditional correlation, oil futures

JEL CLASSIFICATION

E44; G12; G15

1|INTRODUCTION

As of 2018, the crude oil futures markets have been dominated by two international parties: West Texas Inter-

mediate(WTI)intheU.S.andEurope’sBrentcrude.

1

Despite being the world’s largest and fastest‐growing oil

consumer, Asia, at this point in time, has lacked a leading crude oil futures market.

2

Previous attempts to

establish a crude oil futures market have been made in Singapore, Japan, India, and Dubai, but have ultimately

been discontinued or thinly traded; the exception is the crude oil futures market in Dubai. In particular, the

Dubai Mercantile Exchange’s Oman futures market reflects, to a certain extent, the conditions in the Asian

market, and is considered to be the regional benchmark for Middle East supplies sold to Asia. However, since its

inception in 2007, it has failed to garner great liquidity, indicating that it is not frequently used among market

participants.

1

WTI is the main benchmark for the U.S. crude grades and a crucial hedging tool for its oil industry. Brent, priced off North Sea oil, is the primary value marker for European, the Middle Eastern, and

African crudes.

2

According to the U.S. Energy Information Administration (EIA), Asia and Oceania accounted for 35% of global demand for oil and other liquid fuels in 2017, up from just 30% in 2008.

On March 26, 2018, China launched its yuan‐denominated crude oil futures contract on the Shanghai International

Energy Exchange (INE), a subsidiary of Shanghai Futures Exchange. Reasons to launch the contract include the

increasingly urgent need for China to establish a contract based on supply and demand conditions in Asia as well as

mitigating currency risk for Chinese refiners and consumers, as China already overtook the United States in becoming

the largest crude oil importer in the world in 2017. It may also be related to China’s ambition to augment the global

status of the Chinese currency by shifting more global trade into yuan.

The first INE crude oil nearby futures contract with the September 2018 delivery has already seen far more trading

than the total amount of the Oman oil futures market during the same period, despite its carrying a small fraction of

market shares compared to WTI and Brent. Given China’s position in the world economy and its oil consumption,

along with the extremely rapid growth of its crude oil futures market (which increased 10‐fold in trading volume along

with open interest in the first 3 months after its launch), it would be interesting to assess the international linkage

between Chinese and international major crude oil futures markets, particularly in light of the INE crude oil futures’

goal to become a benchmark in the global crude oil market.

Furthermore, the INE contracts approximate a basket of medium and heavy crudes from the Middle East and China itself

with a significantly higher sulfur content, which is close to the underlying crude oil of Oman oil futures contracts in Dubai;

both WTI and Brent are based on light low‐sulfur crude oils.

3

Thus, China’s oil futures market would become the direct

competitor with Oman’soilfuturesmarket.ThiswouldactasChina’s first step toward becoming an important regional

benchmark, reflecting both medium and heavy sour conditions in Asia, before it potentially becomes a global benchmark.

This study examines return and volatility linkages between the Chinese INE futures, the two international major

futures markets, Brent and WTI, and its regional competitor in Asia—the Oman futures market in the Middle East. It

contributes to the literature in the following aspects.

To our best knowledge, this is the first comprehensive study to explore the long‐run price relationship and return

and volatility dynamic relationships between the newly launched Chinese crude oil futures and international major

crude oil futures markets WTI and Brent. As previous studies (e.g., Lin & Tamvakis, 2001; Liu, Schultz, & Swieringa,

2015) on international linkages of crude oil futures markets primarily focused on the dynamics between WTI and Brent

oil futures markets, this study will offer new insights into international crude oil futures market relationships by

accounting for both China’s and Oman’s oil futures markets, which are different from WTI and Brent in terms of the

quality of crude oil as the underlying asset.

4

An equally noteworthy factor is mentioned in Protopapadakis and Stoll’s study (1983) in which they point out that an

international price relationship for an identical commodity traded across different countries should generally follow the

law of one price for a commodity, and such an relationship may be investigated in “its purest form”when commodity

futures prices are used. As Chinese commodity futures markets as a whole have become the most actively traded since

2010 (with their exchanges having the highest commodity futures trading volume in the world), there is a growing amount

of literature on the linkages of Chinese commodity futures with other global major commodities futures markets: Fung,

Leung, and Xu (2003); Fung, Liu, and Tse (2010); Fung, Tse, Yau, and Zhao (2013) examining the information trans-

mission between various Chinese nonoil commodity futures contracts and the corresponding global futures markets, Jiang,

Su, Todorova, and Roca (2016) examining the spillovers between the United States and Chinese agricultural futures, and Li

and Hayes (2017) investigating price discovery on the Chinese, United States, and Brazilian soybean futures markets.

Crude oil is probably the world’s most important and most traded commodity, and with China playing such a

crucial role in the world economy, particularly in the commodity markets, this study would fill in an important gap in

the literature on international commodity futures market linkages in particular, and international commodity market

linkages in general. In our initial findings, we discovered two‐way pronounced return and volatility transmissions

between international major oil futures and China’s oil futures market when the latter was still in its infancy (only 3

months old during the sample period for the baseline analysis). The transmissions displayed stronger results than the

case of the Oman oil futures in the Middle East which had existed for over 10 years.

Extending the previous literature, we comprehensively investigated whether all conditional correlations and volati-

lities show asymmetry across all four international oil futures markets (WTI, Brent, INE, and Oman). Such asymmetry in

volatilities and correlations can potentially shed light on the degree of downside risk of international oil futures markets

3

Both Brent and WTI are classified as a “light sweet”oil blend which means that they are easy to refine compared to heavier and sour oil blends. Specifically, Brent is relatively denser and has a higher

sulfur content than WTI.

4

For example, Lin and Tamvakis (2001) document substantial price spillover effects when both Brent and WTI markets are trading simultaneously, although Brent morning prices are considerably

affected by the WTI closing prices of the previous day. Liu et al. (2015) show that there is a decreasing level of cointegration between Brent and WTI markets.

YANG AND ZHOU

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