Regular articleSpillovers among energy commodities and the Russian stock market☆
Introduction
Russia represents a major worldwide exporter of crude oil, natural gas, gold and coal. In 2019, the export of these energy commodities amounted to $123 billion (crude oil), $66.2 billion (refined oil products), $24.55 billion (natural gas) and $ 22.09 billion (coal). Russia is the world’s third-largest producer of crude oil with an estimated 10 million barrels per day and a share of the world total equal to 11%.1 Energy commodities are the main drivers of the Russian economy with the Oil & Gas and Metals & Mining sectors representing 42% and 24% of the total stock market capitalisation in December 2020, respectively. Energy exports play a central role in the Russian economy making it vulnerable to price fluctuations and shocks in the commodity markets (e.g., see World Bank, 2018).
The Russian economy is highly engaged in international trade. In 2019, the Russian trade of goods and services with the rest of the world amounted to $674 billion, where almost 50% of such trade involved China, Europe and the United States (United Nations, 2020). The country is considerably exposed to the trade activity of its partners, not only in terms of imports (i.e., machines, automotive and chemicals) and exports (i.e., energy commodities), but also in terms of capital flow restrictions. For instance, Gurvich and Prilepskiy (2015) has found that Western financial sanctions during the period 2014–2017 directly affected Russian state-controlled banks, oil and gas companies. In addition, it had indirect effects on non-sanctioned firms by reducing foreign direct investments.
Several studies have highlighted that Russia is an important player at the geopolitical level. According to Caldara and Iacoviello (2018) and Davis (2016), economic and political crisis, as well as war events that originated in Russia, are linked with episodes of economic uncertainty (e.g., the annexation of Crimea followed by the international sanctions and the Russian financial crisis of 2015). Our study takes a further step in this direction and shows that these events are intertwined with international financial and economic crises as well as with the shocks in the commodity markets.
With respect to the previous literature, we contribute in different ways. Firstly, we measure the spillover effects in the Russian stock market, energy commodities and its main trading partners (China, EU and US) caused by shocks in returns and volatility. Secondly, we analyse the importance of the main Russian industrial sectors in terms of shock propagation to international and commodity markets. In particular, we assess the effects that strategic Russian industries, such as Oil & Gas and Metals & Mining, have on major energy commodities. Thirdly, we disentangle the sources of the spillover that originated from the stock and energy commodity markets and find a direct effect of Russian and global geopolitical events on energy commodity volatility spillovers.
We make use of the variance decomposition approach proposed by Diebold and Yilmaz, 2009, Diebold and Yilmaz, 2012 which allows us to measure the dynamics and the intensity of the shock transmission. The connectedness across different types of markets and industries represents a central focus in the role of supervision carried out by central banks and the measurement of risk for institutional investors. We consider the period from January 2005 to December 2020 at weekly frequency, which encompasses major recent economic and financial crises, as well as political and war upheavals that affected the Russian economy. The sample also includes the recent crises caused by the outbreak of the COVID-19 pandemic.
Our findings show that the Russian Oil & Gas sector is a net contributor in terms of spillovers that affect crude oil, both in return and volatility. Moreover, we find that the Oil & Gas and Metals & Mining sectors affect gold. Those industries also have the highest spillovers in terms of returns and volatility impacting other Russian sectors. As expected, the Russian market is highly interdependent with the international financial markets.
Through spillover indicators, we identify the booms and busts which occurred in the financial and commodities markets, as well as the political and war episodes that affected the Russian economy. Our findings show that there are both country-specific and international events that provoked spillover in both returns and volatility. In terms of Russian-specific events, we identify: (i) the Russian and Belarus energy disputes in 2007; (ii) the Russian and Ukrainian disputes in 2008–2009; (iii) the Russian industrial crisis in 2013; (iv) the annexation of Crimea by the Russian Federation with the first and second rounds of international sanctions in 2014; (v) the Russian financial crisis in 2015; and (vi) the third round of sanctions against Russia in response to the Annexation of Crimea in 2017. International events involve: (i) the Global Financial Crisis; (ii) the European Debt crisis; and (iii) the oil price plunge in 2015–2016. We also identify large increases in both return and volatility spillovers corresponding with the recent outbreak of the COVID-19 pandemic.
Our analysis assesses the dynamic net contribution of the Oil & Gas and Metals & Mining sectors towards the other variables of interest. Overall, we find that the Oil & Gas net spillover indexes, for both returns and volatility, increase in correspondence with well-identified episodes of the full spillover indexes. These entail the Russian and Belarus energy disputes, the Global Financial Crisis and the first round of international sanctions imposed by the US and the EU. Moreover, we identify one major peak in the net volatility spillover index for the Oil & Gas sector coinciding with the second round of sanctions on Russia imposed by the EU and the US in response to the annexation of Crimea. On the other hand, the increases in Metals & Mining net spillover indexes for both returns and volatility are mainly associated with specific shocks affecting this industry. Interestingly, we find that both the Oil & Gas and Metals & Mining sectors are net shock receivers during the spread of the COVID-19 pandemic.
Finally, we measure the relationship between the estimated rolling spillover indexes and Russian geopolitical uncertainty. We distinguish between local and global events and also include relevant factors, such as the economic and policy uncertainty and the market uncertainty that originated during the COVID-19 pandemic. In this regard, we consider the spillovers that stem from the stock market and the commodity market. Our findings indicate that the variation in the Russian geopolitical uncertainty has a positive impact on the changes in the energy commodity volatility spillover. This confirms that Russian political crises and war episodes influence the spillover mechanism of those commodities in terms of risk. Interestingly, we find that the COVID-19 pandemic has increased the market volatility spillover, whereas it has lowered the commodity spillover. This asymmetry is due to the economic consequence of the pandemic that has triggered the volatility spillover mechanism of the stock markets, which represents a leading indicator for the current and future expectations of the state of the economy.
We believe that our findings provide interesting implications for portfolio risk managers and policymakers. Portfolio risk managers are interested in understanding the drivers of return and volatility spillovers to properly manage the impact of geopolitical uncertainty on the riskiness of their portfolios. Accurate knowledge of return and volatility spillovers between the Russian financial market and the energy commodities during economic and political crises, as well as war events – which are associated with high financial spillover – represents an important element that can benefit portfolio diversification. For instance, our findings indicate that an increase in Russian geopolitical uncertainty has a direct impact on the spillover volatility risk of the energy commodities such as crude oil, natural gas, and coal. In our view, this has direct implications for the asset classes invested in energy and developing markets. On the other hand, policymakers may adopt policy actions in order to ensure financial stability and monitor the effect of the increase in geopolitical risks that may affect energy commodity prices and consequently, inflation dynamics.
The rest of the paper is organised as follows. Section 2 gives a summary of how our paper fits within the literature. Section 3 describes the implemented methodology. Section 4 presents the empirical analyses. Finally, the last section concludes.
Section snippets
Relation to previous literature
To the best of our knowledge, there are no prior studies that specifically focus on the risk spillovers concerning the Russian stock market and its industrial sectors, with energy commodities and international financial markets.
Our study is related to three branches of the literature. The first branch concerns the studies that investigate the relationship between the BRIC area and emerging countries where Russia is a member of this group. For instance, Mensi et al. (2014) analyse the
Empirical methodology
In this section, we present the variance decomposition approach proposed in Diebold and Yilmaz, 2009, Diebold and Yilmaz, 2012. The variance decomposition is particularly suitable for the purposes of our analysis since it allows us to measure how much of the future uncertainty of a given considered asset (market, sector or commodity) depends on shocks coming from asset , at a given horizon. The influence of variable on the future error variance of variable is interpreted as a spillover
Data
We consider the sample period that goes from the second week of January 2005 to the fourth week of December 2020. This period is marked by several episodes of widespread instabilities for oil prices (large fluctuations during 2009–2013 and 2016–2018), natural gas prices (strong increases and plunges during 2007–2010 and 2014–2018) and coal prices (significant variations during 2007–2011 and 2013–2017). In the same period, several major events affected the Russian economy, such as the dispute
Conclusion
Recently, the Russian economy has undergone substantial changes and most of its industrial sectors have experienced the process of financialization. At the same time, the Russian economy continues to be heavily dependent on energy commodities production. In addition, the COVID-19 pandemic has generated a dramatic crisis due to the negative consequences of general lockdowns and travel limitations.
In this paper, we examine the connectedness between the energy commodities produced in Russia (crude
CRediT authorship contribution statement
Michele Costola: Conceptualization, Methodology, Software, Data curation, Writing – original draft, Writing - review & editing. Marco Lorusso: Conceptualization, Methodology, Software, Data curation, Writing – original draft, Writing –review & editing.
Declaration of Competing Interest
The authors declare that they have no known competing financial interests or personal relationships that could have appeared to influence the work reported in this paper.
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This paper benefited from comments received from Massimiliano Caporin, Mauro Costantini, Antonio Paradiso, Francesco Ravazzolo, and the participants at the 12th International Conference on Computational and Financial Econometrics, University of Pisa (Italy). We would like to thank Robert Hornegold for his excellent research assistance. The usual disclaimer applies.