Shift‐contagion in energy markets and global crisis

• Author: Mehdi Mili,Frédéric Teulon,Jean‐Michel Sahut
• DOI: http://doi.org/10.1002/for.2654
• Date: 01 August 2020
• Published date: 01 August 2020

SPECIAL ISSUE ARTICLE

Shift-contagion in energy markets and global crisis

Mehdi Mili

1

| Jean-Michel Sahut

2

| Frédéric Teulon

3

1

College of Business Administration,

University of Bahrain, Saar, Bahrain

2

IDRAC Business School, Lyon, France

3

IPAG Business School, Paris, France

Correspondence

Jean-Michel Sahut, IDRAC Business

School, 47 Rue du Sergent Michel Berthet,

69009. Lyon, France.

Email: jmsahut@gmail.com

Abstract

This paper presents an analysis of shift-contagion in energy markets, testing

whether linkages between returns in energy markets increase during crisis

periods. The research presented herein demonstrates how common movement

between energy markets increases due to (i) shift-contagion across energy mar-

kets, reflected by structural transmission of shocks across markets and

(ii) larger common shocks operating through standard cross-market interde-

pendences. A regime-switching model was developed to detect shift-contagion

across energy markets. In the approach adopted herein, the occurrence of

shift-contagion is endogenously estimated rather than being exogenously

assigned. The results show that shift-contagion has been a major feature of

energy markets over the last decade. Evidence is presented which demonstrates

that the linkages between energy markets do not appear to be stable. These

results are remarkably accurate for forecasting Brent and natural gas for hori-

zons for up to 50 days. Conversely, for WTI (West Texas Intermediate oil) and

coal, the model performs well only for forecasting very short horizons (up to

20 days). For all products, the model shows significant biases for long horizons.

KEYWORDS

energy markets, forecasting, regime switching, shift-contagion, structural transmission

1|INTRODUCTION

Due to the nature of traded energy products, all previous

empirical studies, without exception, have presented evi-

dence that energy markets are interdependent. Crises

and volatility shocks spread from one market to another

with remarkable speed.

In this study, the authors examine the spillovers of the

returns of Brent oil, n atural gas, coal, and W est Texas

Intermediate oil (WTI), and test whether linkages between

returns in energy markets increase during crisis periods.

They demonstrate how common movement between

energy markets increases due to (i) shift-contagion across

energy markets, reflected by structural transmission

of shocks across markets and (ii) larger

common shocks operating through standard cross-market

interdependences.

Previous empirical works have comprised several defi-

nitions of contagion, and each attempt to explain the pro-

cess quantitatively. The most common definition is that

of Eichengreen, Rose, and Wyplosz, (1996) defining con-

tagion as a significant increase in the probability of a cri-

sis in one country, conditional on the occurrence of a

crisis in another country. Indeed, this definition is often

adopted in empirical work, particularly in those works

which model a crisis occurring due to a collapse of the

exchange rate. However, in practice, this definition

requires a sample of countries, most of which have expe-

rience of such crises.

Another strand of the literature (Bekaert, Harvey, &

Lundblad, 2005; Caporale, Howells, & Soliman, 2003;

Rigobon, 2003) suggests that contagion occurs when vola-

tility spreads from the financial market of the country in

crisis, to the financial markets of other countries. In fact,

Received: 22 November 2018 Revised: 14 May 2019 Accepted: 3 January 2020

DOI: 10.1002/for.2654

Journal of Forecasting. 2020;39:725–736. wileyonlinelibrary.com/journal/for © 2020 John Wiley & Sons, Ltd. 725