Energy Economics 83 (2019) 119–143

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Energy Economics

journal homepage: www.elsevier.com/locate/eneeco

Time-varying volatility spillover between Chinese fuel oil and stock index
futures markets based on a DCC-GARCH model with a
semi-nonparametric approach
Yang Hou a, Steven Li b,⁎, Fenghua Wen c
a
School of Accounting, Finance and Economics, Waikato Management School, University of Waikato, Hamilton 3240, New Zealand
b
Graduate School of Business and Law, RMIT University, Melbourne, VIC3000, Australia
c
School of Business, Central South University, Changsha, China

a r t i c l e i n f o a b s t r a c t

Article history: This paper reveals some new evidence on the volatility spillover between fuel oil and stock index futures markets
Received 16 August 2018 in China by considering its time-variant feature. Time-varying effect is specified by the Legendre polynomials in a
Received in revised form 21 March 2019 DCC GARCH model. Moreover, the semi-nonparametric (SNP) approach accounting for marginal excess kurtosis
Accepted 27 June 2019
and asymmetry is applied. We find different time-evolving patterns of volatility spillover across multiple periods
Available online 02 July 2019
due to the structural breaks. The direction of mean volatility spillover is found to be bilateral. Moreover, the
Keywords:
strength of mean volatility spillover shows that the effect from stock index to fuel oil futures is much stronger
Chinese stock index futures than the other way around. This implies that the stock index futures market plays a leading role in information
Chinese fuel oil futures processing. These findings have important implications for the fuel oil stakeholders as well as risk management.
GARCH models © 2019 Elsevier B.V. All rights reserved.
Time-varying volatility spillover
SNP approach

1. Introduction
Considered as the life support for many economies, oil is one of the
most important commodities in global financial markets. There is an in-
creasingly important relationship between oil and global stock markets,
which facilitates investors to use oil-related securities for effective risk
management and portfolio diversification. Hence, the interactions be-
tween stock and oil prices have been explored extensively in the past
few decades. Some studies reveal positive correlations between oil
and global stock markets (Choi and Hammoudeh, 2010; Filis et al.,
2011; Guesmi and Fattoum, 2014; Phan et al., 2015). Furthermore, the
correlations are found to be stronger after the Global Financial Crisis in
2008 (Creti et al., 2013; Sadorsky, 2014). Some other studies find that
price shocks in the oil market can spill into the equity markets and
thus cause a significant effect on volatility of the latter. These studies in-
clude Jones and Kaul (1996), Driesprong et al. (2008), Malik and Ewing
(2009), Narayan and Sharma (2011), Arouri et al. (2011a), Arouri et al.
(2012), Sadorsky (2012), Chang and Yu (2013), Cunado and de Gracia
(2014), Madaleno and Pinho (2014), Olson et al. (2014), Phan et al.
(2016), among others. In contrast, a few studies such as Chen et al.
(1986), Huang et al. (1996), Lee et al. (2012), Mensi et al. (2013) and
Chang et al. (2013) claim that the oil prices are incapable of transmitting
information into the equity markets.
⁎ Corresponding author.
E-mail address: steven.li@rmit.edu.au (S. Li).
So far, the evidence on the co-movement between oil and stock mar-
kets has focused mainly on developed economies. Some efforts have
been made to examine the relationships between the global oil prices
and stock markets in emerging economies including oil-exporting
countries. Most studies find that oil prices exert a significant impact
on the latter in terms of volatility dynamics (Malik and Hammoudeh,
2007; Arouri et al., 2011b; Lin et al., 2014; Filis et al., 2011; Guesmi
and Fattoum, 2014).
There have been a few studies exploring the informational interac-
tion between the global crude oil and domestic equity markets in
China. Though Cong et al. (2008) find there is no effect of crude oil prices
on Chinese stock market indices, some recent studies find that a signif-
icant linkage between global oil prices and Chinese stock market exists
where the former exerts a vital impact on the pricing dynamics of the
latter (Ji and Fan, 2010; Du et al., 2010; Li and Leung, 2011; Zhang and
Wang, 2014; Li et al., 2012).
Due to the rapid development of the Chinese economy, there has
been a dramatic growth in domestic energy markets. Among the do-
mestic energy products, fuel oil, processed from crude oil, is of great im-
portance. This is because fuel oil is heavily traded in the most developed
regions in China by its producers and consumers and makes marked
contributions to the growth of Gross Domestic Product (GDP) (Wei,
2012; Li et al., 2017). In addition, the fuel oil futures contracts, intro-
duced in the Shanghai Futures Exchange (SHFE) in 2004, have been ex-
tensively traded by the local fuel oil players and other investors. At the
end of 2009, trading volume of the fuel oil futures became the world's

https://doi.org/10.1016/j.eneco.2019.06.020
0140-9883/© 2019 Elsevier B.V. All rights reserved.
120 Y. Hou et al. / Energy Economics 83 (2019) 119–143
third largest, following the WTI crude oil futures on the NYMEX and
Brent crude oil futures on the IPE (Wei, 2012). Thus, exploration on pric-
ing behaviour of the fuel oil futures in China and its interactive effects
can shed light on stylized facts of energy market in a fast-transiting
economy and has important implications for a variety of stakeholders.
However, there have been few studies on the pricing dynamics of
the fuel oil futures market. Volatility dynamics in both short and long
ranges is examined by Wei (2012) and Liu and Wan (2012). Wang
et al. (2007) assess price discovery of the fuel oil futures market and
suggest it functions as expected. Li et al. (2017) find there is one-way
volatility spillover from energy stock index to fuel oil futures market
but two-way feedback between the former and fuel oil spot one.
To our best knowledge, there is hardly any research done on the vol-
atility spillover between the fuel oil futures market and the equity mar-
kets in China. China Securities Index (CSI) 300 index futures market not
only represents the overall performance of the A-share equity market
(Yang et al., 2012; Hou and Li, 2015; Xu and Wan, 2015), but also
operates in a special trading context in terms of security supply, settle-
ment cycle and investor composition due to regulatory policies by Chi-
nese government (Chen et al., 2013; Xie and Mo, 2014). On the other
hand, the fuel oil futures market is also closely monitored by the Chinese
government via a domestic oil price control policy which results in de-
layed and discretional adjustments of domestic oil prices in response
to international oil price changes with the purpose of stability control
(Li et al., 2017). Hence, both fuel oil and CSI 300 futures markets operate
in a similar but special trading circumstance.
It is well-known that futures markets impound new information
into prices faster than the spot markets and provide effective price dis-
covery function due to lower transaction costs and less regulatory con-
straints. Thus they can be better representatives for asset markets
(Chan, 1992; Fleming et al., 1996; Wu et al., 2005; Hou and Li, 2016)
and the futures contracts are chosen for this study instead of fuel oil
and stock index spot markets. The recent literature has concluded that
the CSI 300 index futures market leads the underlying spot market
and provides effective price discovery function. Chen et al. (2013) find
it functions as expected in stabilising the spot market volatility. Hou
and Li (2013, 2015) and Xu and Wan (2015) find that the futures mar-
ket performs well in price discovery. With respect to informational role
of the fuel oil futures market, Wang et al. (2007) and Li et al. (2017) find
that the fuel oil futures market is the information transmitter. Therefore,
one would expect that findings using futures is likely to shed more light
on the oil-equity interactions than using spot ones.
Furthermore, it is of great interest to explore a latent time varying
feature of volatility spillover between the fuel oil and stock index fu-
tures markets in China. Economic reasoning of such feature might relate
to time variant behaviour of informed traders who actively trade in
these two markets. One can expect that informed traders shift between
the fuel oil and stock index futures markets across time since they are
not likely to stay in one market for long comparing to the other.1 In-
formed traders always prefer to trade and swamp in the market with
favourable conditions as they perceive. A classic theory that aligns
with such behaviour is the trading costs hypothesis by Fleming et al.
(1996). One of crucial market factors for the behaviour might be degree
of financialization of fuel oil market in China (Li et al., 2017).
Financialization of fuel oil market is a vital feature of local energy mar-
ket because fuel oil is one of the most important inputs to local eco-
nomic development. Such feature is closely monitored and intervened
by the Chinese government (Li et al., 2017). The local smart money in-
vestors recognise the importance of financialization. Hence, whether in-
formed traders prefer to trade in the fuel oil market is heavily affected
by the degree of financialization of that market and their perception.
1
We only focus on two financial markets, i.e., Chinese fuel oil and stock index futures
markets. The other financial markets in China are not considered due to the scope of this
paper. Hence, we stick to activities of informed traders in these two markets only.
The degree of financialization can vary across time, depending on
whether speculative demand dominates over the real one, when fuel
oil production is stable (Li et al., 2017). Whether smart money consider
high degree of financialization to be beneficial might vary with the status
quo of the economy. For instance, if the economy is expanding, the excess
liquidity runs into the fuel oil market and makes it more financialised. In
such a situation, informed traders might perceive high degree of
financialization to be detrimental and thus do not prefer to trade in
that market. They would rather trade more in the counterpart stock
index futures market. Under different status of economy, informed
traders have varying views towards financialization of the fuel oil market.
Accordingly, they would have changing preferences to actively trade in
the fuel oil or stock index futures market. Such behaviour would result
in time variation of information contents of these two markets (Admati
and Pfleiderer, 1988; Back and Pederson, 1998). Hence one can expect
that volatility spillover effect would be time varying since it mirrors infor-
mation contents (Chan et al., 1991; Chan, 1992; Engle et al., 1990).
This paper contributes to the literature by extending the static vola-
tility spillover to a time varying one. As far as we know, there have been
hardly any studies examining the time varying volatility transmission
between oil and stock markets. The extant literature has only focused
on the stylized facts of static volatility spillover in oil-equity relation-
ships. Since the time variant spillover is connected with financialization
of fuel oil market and local informed traders' activities in China, our re-
sult can shed more light on pricing behaviour in the two Chinese finan-
cial markets operating in a special regulatory context. The empirical
findings of time varying spillover can provide more implications than
static one for local stakeholders in terms of investment and risk man-
agement such as volatility forecasting, portfolio diversification and
cross hedging strategy.
Following Joo and Park (2017), this study employs the Legendre
polynomials that adequately approximate unknown smooth functions
to specify time-varying feature of volatility spillover between the two
futures markets in China. Moreover, this study examines the dynamic
volatility spillover by means of a dynamic condition correlation (DCC)
generalised autoregressive conditional heteroscedasticity (GARCH)
model incorporating the Legendre polynomials into conditional vari-
ance equation.
Joo and Park (2017) recognise the appropriateness of the Legendre
polynomials with respect to modelling unknown time variation process
via using it to gauge time varying investors' risk aversion coefficient. It is
claimed that the Legendre polynomials can flexibly and accurately cap-
ture the non-linear effects of time on a variable under question when its
latent exact factors are reluctant to settle. Moreover, smoothness of the
forecasting functional form for the variable can be achieved. This is be-
cause it proposes the variable to be factored by a various number of con-
cise time functions with multiple powers. A flexible non-linear function
of time for a variable becomes available under such setting. This feature
enables the polynomials work well with the maximum likelihood esti-
mation (MLE) for the multivariate GARCH model.
Furthermore, our study makes a methodological contribution in ad-
dressing the non-normality phenomenon of financial time series in a
more accurate way for modelling volatility spillover between oil and
stock markets. Excess kurtosis and asymmetry are widely observed in fi-
nancial time series, leading to deviations from normal distribution
(Bollerslev, 1987; Baillie and Bollerslev, 1989; Park and Jei, 2010). Devi-
ations from normality of financial time series comprise a long-lasting
issue for the examination of volatility spillover in a multivariate
GARCH family framework. Failure to take them into account in the esti-
mation of multivariate GARCH family models can result in substantial
loss of efficiency (Engle and Gonzalez-Rivera, 1991; Park and Jei,
2010). This problem might further damage the estimation accuracy
and even impair unbiasedness of estimation results. However, regard-
ing volatility spillover between oil and stock markets, previous studies
commonly assume multivariate normal distribution in the estimation
procedure (e.g. Mensi et al., 2013; Awartani and Maghyereh, 2013;
 Y. Hou et al. / Energy Economics 83 (2019) 119–143
Arouri et al., 2012; Sadorsky, 2014; Li et al., 2017). These studies fail to
capture the marginal excess kurtosis and non-zero skewness of univar-
iate time series within the multivariate model system which are com-
mon culprits for deviations from normality (Baillie and Bollerslev,
1989; Engle and Gonzalez-Rivera, 1991; Del Brio et al., 2011; Ñíguez
and Perote, 2016; Del Brio et al., 2017). Thus one can expect that ac-
counting for marginal third and fourth moments of return distribution
in the estimation process of multivariate GARCH model can bring
about substantial benefit for the accuracy of estimation results.2
This paper also contributes to the literature by incorporating the SNP
approach to account for non-normality of return distribution in the
model estimation procedure for time varying volatility spillover. The
SNP approach can accurately capture both the marginal third and fourth
moments of multivariate return distribution (Ñíguez et al., 2009). The
empirical advantages of the SNP approach are reflected by a simplified
and flexible two-step estimation procedure for the DCC-GARCH struc-
ture. The SNP approach developed by Del Brio et al. (2011) and
Ñíguez and Perote (2016) succeeds in handling this issue by offering a
multivariate distribution that incorporates the marginal moments of
higher order (N2) in the estimation procedure. The approach enables
separability in estimation between the Gaussian component and the
SNP component that stems from a series of derivatives equations over
the standard normal density function, leading to a more simplified
two-step estimation procedure than the conventional assumption of
non-normality. The SNP approach has never been used in combination
with the DCC GARCH model that estimates the time varying volatility
spillover. It is demonstrated that the SNP approach works well for the
DCC model estimating the time-varying volatility spillover between
the Chinese fuel oil and stock index futures markets.
We find significant and new evidence on the evolution patterns of
volatility spillover across multiple periods under the situation that the
long-run cointegration between oil and stock index prices is non-
static. The result has important implications for investors in both fuel
oil and stock index futures markets.
The remainder of this paper is organised as follows. Section 2 re-
views the literature. Methodology and sample are illustrated in
Sections 3. Section 4 shows the empirical results and delivers some dis-
cussions. The conclusion is drawn in Section 5.
2. Literature review
Since the oil crisis in 1970s, studies on the relationship between oil
price and equity markets have been of significant interests to financial
practitioners, market participants and researchers. It is generally
found that the oil market has a negative impact on the stock market per-
formance and has some forecasting power to the latter (Jones and Kaul,
1996; Driesprong et al., 2008). The impacts of oil markets on stock mar-
kets vary across sectoral locations (Narayan and Sharma, 2011; Malik
and Ewing, 2009; Arouri et al., 2011a). Some recent studies reveal
high conditional correlations between oil prices and stock markets in
both developed and emerging economies (e.g. Creti et al., 2013;
Madaleno and Pinho, 2014; Cunado and de Gracia, 2014; Choi and
Hammoudeh, 2010; Filis et al., 2011; Guesmi and Fattoum, 2014; Phan
et al., 2015, among others).
The information transmission between crude oil and stock markets
has drawn a lot of attention in the literature as well. Volatility spillover
between the crude oil and stock markets, as a critical indicator for cross-
market information transmission, has been intensively explored. Most
of the studies find that the stock and crude oil markets interact with
each other with oil prices as the leading volatility transmitter. Such ef-
fect is found significantly in stock markets in developed economies in-
cluding US, UK, Canada and European Monetary Union (EMU) (e.g.
2 3
As confirmed by the Jarque-Bera (JB) test in Table 2 below, our data do not follow a
normal distribution. Hence, accounting for non-normality is necessary for estimating the
GARCH model.
121
Malik and Ewing, 2009; Narayan and Sharma, 2011; Arouri et al.,
2011a; Sadorsky, 2012; Chang et al., 2013; Cunado and de Gracia,
2014; Madaleno and Pinho, 2014; Olson et al., 2014; Phan et al., 2016;
Reboredo and Ugolini, 2016; Chang and Yu, 2013; Arouri et al., 2012,
among others). Meanwhile, the dominant effect of crude oil prices on
stock prices is also unveiled in developing economies and regions that
import oil including the five BRICS countries (Brazil, Russia, India,
China and South Africa), Gulf Cooperation Council (GCC) countries, Mid-
dle East and North Africa (MENA) countries and other emerging econo-
mies in Asia, Europe and North and South Americas (Malik and
Hammoudeh, 2007; Arouri et al., 2011b; Lin et al., 2014; Filis et al.,
2011; Guesmi and Fattoum, 2014; Sadorsky, 2014; Reboredo and
Ugolini, 2016; Awartani and Maghyereh, 2013; Bouri, 2015; among
others). Worth mentioning, some studies find that the stock markets
lead the crude oil markets in terms of volatility spillover and signifi-
cantly explain the latter's performance (e.g. Mensi et al., 2013).
Research on the informational role of world oil prices in China has
been expanding in recent years. Some studies concentrate on the im-
pacts of world oil prices on the Chinese domestic energy and equity
markets. Conclusions thus far are mixed. A significant volatility linkage
between global oil markets and domestic oil prices and stock markets
is unveiled, indicating a leading role of the world oil prices (Chen
et al., 2009; Liu et al., 2013; Ji and Fan, 2010, 2016a; Du et al., 2010; Li
and Leung, 2011; Zhang and Wang, 2014). Moreover, a panel
cointegration relationship is found to exist between oil and stock prices
at the disaggregated sector level, along with a long run positive effect of
real oil price on sectoral stocks (Li et al., 2012). In contrast, Cong et al.
(2008) find that oil price shocks do not show a significant impact on
the real stock returns of most Chinese stock market indices.
The research on the informational role Chinese domestic oil prices
has been active in recent years. For example, Wu and Li (2013) find
that information of local crude oil spot market transmits to corn and
fuel ethanol markets but not the other way round. Thus, an important
informational role of the local crude oil market is confirmed.
Considerable attention has been given to the Chinese fuel oil market
in the recent literature. This is because fuel oil is one of the most impor-
tant energy products for the China's economy and China is the largest
fuel oil consumer in Asia (Liu and Wan, 2012; Wei, 2012).3 Moreover,
the fuel oil futures contracts, introduced in 2004, have been extensively
used by local fuel oil producers and consumers for risk management
purposes (Liu and Wan, 2012; Wei, 2012). They are also used by local
speculators for multiple trading strategies. At the end of 2009, the trad-
ing volume of fuel oil futures contracts in China became the third largest
among the global oil futures markets.
Although the fuel oil market is important for the Chinese economy,
its pricing dynamics has been rarely explored in the literature. Liu and
Wan (2012) and Wei (2012) examine the stylized facts of volatility be-
havior of univariate fuel oil futures price series. Wang et al. (2007) reveal
the price discovery function of the fuel oil futures market and find that it
leads the underlying spot market. Ji and Fan (2016b) report a greater in-
fluence of the Chinese fuel oil futures market on other commodity mar-
kets than the domestic crude oil market in light of contemporaneous
causality. Li et al. (2017) reveal significant bidirectional spillover be-
tween fuel oil spot and local energy stock indices. They find that the en-
ergy stocks lead the fuel oil futures in the information transmission.
To the best of our knowledge, the issue of volatility spillover be-
tween the Chinese fuel oil futures market and the Chinese stock index
futures market has never been studied. The latter represents the overall
performance of local A-share market (Yang et al., 2012). These two mar-
kets operate under similar and strict trading environments where trad-
ing activities are closely monitored by Chinese government. Hence, it is
challenging and interesting to study the volatility spillover between the
The fuel oil product, processed from crude oil, is primarily traded in the Pearl River
Delta and the Yangtze River Delta regions and is a vital input for business activities in these
areas (Li et al., 2017). These two regions are critical to the Chinese economy.
122 Y. Hou et al. / Energy Economics 83 (2019) 119–143

two markets to enrich relationships between energy and equity mar- If Eq. (1) is validated, that is, cointegration exists between Ot and Pt, a
kets. This paper aims to fill this research gap in the literature. bivariate vector error correction model (VECM) is represented as
This paper also has some unique features including addressing the
p p
latent time-varying spillover and using a SNP distribution recently de- Δot ¼ a0 þ a1 ut−1 þ ∑i¼1 a11 12
i Δot−i þ ∑i¼1 ai Δpt−i þ e1;t : ð2Þ
veloped by Del Brio et al. (2011), Ñíguez and Perote (2016) and Del
p 21 p 22
Brio et al. (2017). More details regarding these features are given in Δpt ¼ b0 þ b1 ut−1 þ ∑i¼1 bi Δpt−i þ ∑i¼1 bi Δot−i þ e2;t : ð3Þ
the methodology section below.
where Δot and Δpt are the first order differences of Ot and Pt, respec-
3. Methodology tively. ut−1 denotes the lagged error correction term or innovations of
cointegrating equation of Eq.(1) that incorporates time varying
In this paper, we employ the Park and Hahn (1999) cointegration t
cointegrating coefficient βð Þ. The lag order p is determined by the
test (hereafter referred to as PH test) to test the existence of n
Akaike Information Criteria (AIC).
cointegration under the consideration of a time varying cointegrating  
coefficient.4 The PH test relaxes the assumption of the conventional e
Let et be a vector of innovations of Eqs. (2) and (3)., i.e., et ¼ 1;t .
e2;t
Johansen cointegration test that the cointegration relationship is
‘time-invariant’. Hence one can expect that the time varying Then we have
cointegration test reveals more reliable result than the static counter-
et j Ωt−1  F ð0; H t Þ: ð4Þ
part. The time varying volatility spillover is specified in a bivariate
DCC-GARCH model developed by Engle (2002)5 with the conditional where Ht denotes a conditional variance-covariance matrix. Ωt−1 is the
dynamics of spillover modelled by the Legendre polynomials. The DCC information set up to time t-1. F(.) denotes a bivariate distribution et fol-
GARCH model is chosen since it not only assures the positive definite- lows. The DCC GARCH model (Engle, 2002) suggests that Ht is
ness of the variance-covariance matrix of the return distribution but it decomposed as
also provides a better estimation for conditional correlations (Tse and
Tsui, 2002). Furthermore, we extend the DCC GARCH model by applying H t ¼ Dt Rt Dt ; ð5Þ
the SNP approach which allows simultaneously accounting for both
asymmetry and fat tails of the return distribution. Under the SNP frame- where
work, both dynamics of the third and fourth moments of the return dis-  1 1

tribution can be captured. Dt ¼ diag h211;t ; h222;t ;

3.1. The DCC-GARCH model and time-varying volatility spillover and

Let Ot and Pt be the natural logarithms of daily prices of the fuel oil Rt ¼ diag fQ t g−1=2 Q t diagfQ t g−1=2 :
and CSI 300 index futures, respectively. If the two series are integrated
at the same order, a potential cointegration relationship where the Alternatively, Dt, Qt and Rt in Eq. (5) can be represented as
cointegrating coefficient is time variant rather than static, is represented 2 3
1
as h211;t 0
Dt ¼ 4 1
5;
0 h222;t


t  
Ot ¼ β0 þ β P t þ ut : ð1Þ
n q11;t q12;t
Qt ¼ ;
q21;t q22;t

where β0 is a constant mean of the equation and ut denotes the error and
t
correction term. βð Þ is the time-varying cointegrating coefficient asso- 2 q12;t 3
n 1 pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
t 6 q11;t q22;t 7
ciated with ð Þ where t is the order of observation in the sample and n 6 7
n Rt ¼ 6
6
7;
7
t 4 q21;t 5
denotes the sample size. We have βð Þ ≡ βðλÞ such that λ ∈ (0, 1]. Ac- pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi 1
n q11;t q22;t
cording to Park and Hahn (1999), the time-series parameters,β(λ), are
approximated by the Fourier flexible form (FFF) functions with kth where h11, t and h22, t are conditional variances of the fuel oil and CSI 300
order where k is some positive integer. According to Joo and Park index futures returns, respectively. Qt is the conditional variance-
t eit
(2017), k is small enough to keep sufficient smoothness for βð Þ. Park covariance matrix of standardized innovations εit ¼ pffiffiffiffiffiffiffi ffi ði ¼ 1; 2Þ
n hii;t
and Zhao (2010) suggest it's better to choose k among a range of  
q 0
small values. We use Bayesian Information Criteria (BIC) to choose the and diagfQ t g ¼ 11;t . q11, t and q22, t are conditional variances
0 q22;t
most appropriate value of k between 1 and 5. Typically, the best value
of ε1t and ε2t, respectively. q12, t (q21, t) is conditional covariance of εit.
of k guarantees the lowest value of BIC for the cointegrating equation
The conditional correlation between the fuel oil and stock index futures
Eq. (1).6 q12;t q21;t
returns in Rt is given by pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi or pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi on the off-diagonal
4
q11;t q22;t q11;t q22;t
More details of the PH test are shown in Section 4.2 and Appendix 3.
5
We apply the Bera and Kim (2002)’s test for the constancy of correlation. The null hy- where these two items are equal. In the DCC-GARCH model, Qt is condi-
pothesis that the correlation is constant over time is rejected. Hence, the DCC model is tioned on the past information set at time t-1. Detailed specification of
employed instead of Bollerslev (1990)’s constant conditional correlation (CCC) GARCH Qt is given in Section 3.1.2.
model. Test results are not reported due to the space limit, but available upon request.
6
In this study, k = 3 for Subsamples 1 and 2 while k = 4 for Subsample 3. The lowest
BIC values associated with these k are −4126.937, −1434.480 and − 3094.296 for Sub-
3.1.1. Conditional variance equation and Legendre polynomials
samples 1, 2 and 3, respectively. Other BIC values with other k up to 5 are available upon The individual GARCH processes specify h11, t and h22, t, respectively.
request. Details of subsampling can be found in Section 4.1 below. To model volatility spillover, hii, t (i = 1, 2) is specified in an extended
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 123

GARCH (Admati and Pfleiderer, 1988) model such as
hii;t ¼ θ0i þ θ1i e2i;t−1 þ θ2i hii;t−1 þ spoi;t e2j;t−1 :
where i = 1, 2; j = 1,2 And i = 1 for j = 2 while i = 2 for j = 1. θ1i ex-
amines the effect of arrivals of new shocks and θ2i captures the effect of
The main interest of this paper is the approximation of spoi, t for i =
1, 2 in Eq. (6).
ð6Þ Given the time varying volatility spillover defined by the Legendre
polynomials in Eqs. (9), (6) can be unpacked as
hii;t ¼ θ0i þ θ1i e2i;t−1 þ θ2i hii;t−1 þ δi;0 e2j;t−1 þ δi;1 ze2j;t−1

old news (persistence). spoi, t captures the time-varying effects of vola- þ δi;2 0:5 3z2 −1 e2j;t−1 þ δi;3 0:5 5z3 −3z e2j;t−1

2
tility spillover between the fuel oil and CSI 300 index futures markets. 4 2
þ δi;4 0:125 35z −30z þ 3 e j;t−1 :
According to Engle et al. (1990), Eq. (6) is theoretically valid if the
long run average variance, which is controlled by the parameters in the where i = 1, j = 2; i = 2, j = 1. z = t/T where t = 1, 2, …, T. Under the
equation, is positive. In other words, the existence of the long-run aver- SNP distribution for innovations, a two-step procedure is applied to the
age variance, which is implied by its positivity, justifies the individual estimation of the DCC-GARCH model.8 The first step involves the esti-
GARCH model specified in Eq. (6) (Bollerslev, 1986; Engle et al., 1990; mation of the individual GARCH models as specified in Eq. (6), assuming
Engle, 2001). If otherwise, the GARCH process is not stationary and a that innovations follow a normal distribution with zero means and con-
family of alternative integrated GARCH model should be considered. ditional variances. Hence, the univariate Gaussian probability density
Following Engle et al. (1990), the long run average variance of function (PDF) is utilized in the Quasi maximum log-likelihood estima-
Eq. (6) that captures the volatility spillover can be calculated as follows. tion (QMLE) procedure for estimating Eq. (6). To make sure the conver-
 
V L;1 gence of the maximized log-likelihood is achieved and the extended
Let VL be a vector of the long run average variances. V L ¼ where
V L;2 GARCH model is justified in terms of positive long run average vari-
VL, 1 and VL, 2 are the long run average variances of the fuel oil and CSI ances, we apply the following process to the estimation.
300 index futures returns, respectively. Corresponding with Eq. (6), First, we select various sets of values as starting values of θ0i, θ1i, θ2i
we have and δi, k (i = 1,2; k = 0,…,4) for the QMLE procedure. The selection pro-
cess stops when the best set of values is obtained to achieve the conver-
V L ¼ ½I−B−C −1 ω: gence of maximized log-likelihood. Second, we pick different values as
    starting values of the conditional variances for iterations of the QMLE.
θ 0 θ11 spo1;t
where I is a 2 × 2 identity matrix; B ¼ 21 ;C ¼ ; We repeat the selection until the best starting values are found to
0 θ22 spo2;t θ12
  achieve the convergence of maximized log-likelihood. At the same
θ time, those best starting values of parameters and conditional variances
and ω ¼ 01 . Note that VL is time varying given that spoi, t(i = 1, 2)
θ02 are supposed to ensure positivity of the long run average variances.9 In
changes over time. VL is static if otherwise. Specifically, we can compute addition, we allow enough iterations for computing log-likelihood and
the long run average variance by the equation choose appropriate algorithms for obtaining estimates. Overall, this pro-
cess is carefully monitored to ensure (i). convergence of maximized log-
1−θ1 j −θ2 j θ0 j
V L;i ¼ θ0i þ spoi;t : ð7Þ likelihood; and (ii). existence of long run average variances.
d d
Furthermore, the estimation of Eq. (6) must ensure estimated condi-
where i = 1, j = 2; i = 2, j = 1. And d = (1 − θ11 − θ21)(1 − θ12 − θ22) tional variance series to be positive. The parameter restriction imposed
− spo1, tspo2, t. on the QMLE process can be realized if the maximized log-likelihood is
Alternatively, the long run average variance can be expressed as7 converged. It is argued that no other actions need to be taken to achieve
that restriction. According to Engle (1982), Bollerslev (1986), Engle
θ0i 1−θ1 j −θ2 j θ0 j (2001) and Engle et al. (1990), the positivity of conditional variance is
V L;i ¼ −spoi;t : ð8Þ
1−θ1i −θ2i d d a necessary condition for the convergence of maximized log-
likelihood. Positive conditional variance also comprises one of the con-
where i = 1, j = 2; i = 2, j = 1. We use the two equations above to cal- ditions for the convergence of maximized log-likelihood in the estima-
culate the long run average variances of the fuel oil and CSI 300 index tion process. Since the process illustrated above secures the
futures markets. The incorporation of the time varying volatility spill- convergence of maximized log-likelihood, we use it to guarantee the
over term spoi, te2j, t−1 into the conventional GARCH (Admati and positivity of conditional variance. One can expect that the estimation re-
Pfleiderer, 1988) model in Eq. (6) is theoretically justified if the com- sults of Eq. (6) make sure the estimated conditional variances are posi-
puted long run average variances are all positive through time. tive given the closely monitored selection process for starting values of
In particular, spoi, t in Eq. (6) is simply specified by the Legendre model parameters and conditional variances. Note that those starting
polynomials as values are controlled to be positive in the selection process.
K
spoi;t ¼ ∑k¼0 δi;k Lðk; zÞ: ð9Þ 3.1.2. Dynamic conditional correlation
Regarding the specification of conditional correlation of Rt, given
where i = 1, 2. z = t/T where t = 1, 2, …, T and T is total sample size. L that Rt is comprised of Qt, Qt is further specified as
(k, z) with k = 0, 1, 2, …, K denotes Legendre polynomials of order K. The
Legendre polynomials described in Appendix D are chosen since they Q t ¼ ð1−λ1 −λ2 ÞQ þ λ1 εt−1 ε0t−1 þ λ2 Q t−1 : ð10Þ
are orthonormal and can approximate an unknown smooth function ar-
bitrarily well (Joo and Park, 2017, pp.45). In this study, we choose 4 for K where εt is a 2 × 1 vector of εit. Q ¼ E½εt εT t  denoting a 2 × 2
following Joo and Park (2017) for analysis according to AIC. Hence the
first five Legendre polynomials are: 8
See details in Section 3.2 below.


2
9
For instance, for Subsample 1, the best starting values of θ01, θ11, and θ21 are 0.00023,
Lð0; zÞ ¼ 1; Lð1; zÞ ¼ z; Lð2; zÞ ¼ 0:5 3z −1 ; Lð3; zÞ 0.15, and 0.60, respectively. The best starting values of δ1, k (k = 0, …, 4) are zero. Similarly,
3

¼ 0:5 5z −3z ; and Lð4; zÞ ¼ 0:125 35z4 −30z2 þ 3 : the best starting values of θ02, θ12, and θ22 are 0.00018, 0.15, and 0.60, respectively. The
best starting values of δ2, k (k = 0, …, 4) are zero. The starting values of conditional fuel
oil and index futures variances are obtained by a backcast procedure imposed on sample
variances with backcast parameter equal to 0.8. Such procedure is supplied by the statis-
7
We would like thank one referee for proposing this equation to calculate the long run tical package. The relevant starting values in Subsamples 2 and 3 are similar to Subsample
average variance. 1 and available upon request.
124 Y. Hou et al. / Energy Economics 83 (2019) 119–143
unconditional covariance matrix of εt. E[.] is the expectation operator. λ1
and λ2 are scalar parameters. The positive definiteness of Qt can be guar-
anteed if λ1 N 0, λ2 N 0 and λ1 + λ2 b 1. Further, Eq. (10) can be unpacked
into the following equations
qii;t ¼ ð1−λ1 −λ2 Þqii þ λ1 ε2i;t−1 þ λ2 qii;t−1 ;
and
qij;t ¼ ð1−λ1 −λ2 Þqij þ λ1 εi;t−1 ε j;t−1 þ λ2 qij;t−1 :
where i = 1, 2; j = 1, 2. qii and qij are the unconditional variance and co-
variance of εt, respectively. From these equations, one can expect that
conditional correlation is driven by the past shocks and its own lagged
values. The effect of the past shocks is captured by λ1 while that of the
lagged values is examined by λ2.
3.2. The SNP approach
Excess kurtosis, corresponding with fat tails of a distribution, is
widely observed in the financial time series (Bollerslev, 1987; Baillie
and Bollerslev, 1989). In addition, financial returns are often skewed
so that capturing the asymmetry of the distribution is needed (Park
and Jei, 2010). Accepting only conditional normality in the estimation
of the multivariate GARCH models for non-normal data could lead to
loss of efficiency (Engle and Gonzalez-Rivera, 1991; Park and Jei,
2010). Thus, the utilization of the conditional distribution that captures
both excess kurtosis and non-zero skewness for the estimation of the
GARCH models can yield more reliable results in cases that the underly-
According to León et al. (2005), a four-order type constrained expansion
used to parsimoniously define the density in terms of its marginal skew-
ness (si) and excess kurtosis (ki) can be shown as
f ðεit jΩt−1 Þ ¼ ϕðεit Þψðε it Þ; ð12Þ
where
ψðεit Þ ¼ 1 þ si ε3it −3ε it þ ki ε4it −6ε 2it þ 3 :
Eq. (12) has a drawback that the probability density is not always as-
sured to be positive given the full domain of the parameter set. An ad-
justed function proposed by Gallant and Nychka (1987) is

f ðεit jΩt−1 Þ ¼ ω−1 2
i ϕðε it Þψi ðε it Þ; ð13Þ
where
2
ωi ¼ 1 þ s2i þ ki :
Note that the function in Eq. (13) can integrate up to one. ωi is the
normalizing factor and f ∗(εit| Ωt−1) is the so-called Gram-Charlier prob-
ability density function (PDF). Ñíguez et al. (2009) state that si and ki in
the transformed function in Eq. (13) accurately capture the dynamics of
the marginal third and fourth moments of returns distribution.
Built upon the marginal standard SNP density function in Eqs. (12)
and (13), the probability density function (PDF) of the multivariate
standard SNP for the vector εt = (ε1t, ε2t,…,εnt) ′ ∈ ℝn can be expressed
as
ing data deviates from normality (Susmel and Engle, 1994; Tse, 1999).  h i1
1
F ðεt jΩt−1 Þ ¼ ð2π Þ−2 jRt j−2 exp − ε0t R−1
n 1 n
According to Del Brio et al. (2011), Ñíguez and Perote (2016), Del t ε t ∑i¼1 ω−1 2
i ψi ðxit Þ ð14Þ
2 n
Brio et al. (2017), the SNP approach has some salient advantages for es-
timating the DCC GARCH model in case that innovations are not normal.
where Rt is the conditional correlation of εt and is normally specified in a
First, the approach proposes an SNP distribution that is straightfor-
multivariate DCC GARCH model (Del Brio et al., 2011; Del Brio et al.,
wardly expanded from the standard normal distribution. The SNP distri-
2017). exp {} is an exponential function. Note that in the multivariate
bution can account explicitly for both marginal skewness and kurtosis of
SNP density function of Eq. (14) the marginal skewness and kurtosis,
multivariate return distribution in the maximum log-likelihood estima-
si and ki (i = 1, 2, …, n), are captured and incorporated in the expres-
tion (MLE) process. This enables the flexibility of incorporating the effect
sions of ω−1i and ψ2i (xit) for each series εit. Consistent with Eqs. (12)
of higher order moments for the estimation process. Second, the log-
and (13), ωi = 1 + s2i + k2i and ψi(xit) = 1 + si(x3it − 3xit) + ki(x4it
likelihood of the SNP distribution is separable from the Gaussian density.
− 6x2it + 3). xit in Eq. (14) can be obtained by
Hence a simple two-step estimation procedure is available: 1). the con-
ditional mean and individual variance are estimated via Quasi MLE −1=2
xt ¼ ðx1t ; x2t ; …; xnt Þ0 ¼ Rt εt : ð15Þ
(QMLE), assuming Gaussian innovations; 2). conditional correlations
and the rest of higher order moments are estimated in the standardized
It should be noted that Eq. (15) yields non-unique forms of xit. Fol-
SNP distribution (zero mean and unit variance). This two-step proce-
lowing Del Brio et al. (2017), this paper adopts the following represen-
dure assures the consistency and efficiency of the model estimates.
tations of xit for n = 2 (bivariate case)
The SNP approach models asset returns distributions arising from
the asymptotic properties of Edgeworth and Gram-Charlier series. 0 1 0 1
Under the weak regularity conditions (Cramér, 1925), the probability 1B 1 1 C 1B 1 1 C
x1t ¼ @qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi þ qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiAε1t þ @qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi−qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiAε2t ;
density function p(εit) of a random variable εit can be governed by an in- 2 2
1þρ 12;t 1−ρ 12;t 1þρ 1−ρ
12;t 12;t
finite series of derivatives of the standard normal density, ϕ(εit). The ex-
pression is ð16Þ

∞ 0 1 0 1
pðε it Þ ¼ ϕðεit Þ∑s¼0 κ is H s ðεit Þ: ð11Þ
1B 1 1 C 1B 1 1 C
x2t ¼ @qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi−qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiAε 1t þ @qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi þ qffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiAε 2t ; :
2 1þρ 1−ρ 2 1þρ 1−ρ
where κis is the cumulant of order s for εit. Hs(.) is the sth order 12;t 12;t 12;t 12;t
Chebyshev-Hermite polynomial. It relates to the sth order derivative ð17Þ
of the normal density function ϕ(εit) as

s where ρ12, t is the off-diagonal element of Rt in Eq. (5) in Section 3.1

d ϕðεit Þ
¼ ð−1Þs ϕðεit ÞH s ðεit Þ: denoting the conditional correlation.
dεit s Based on Eq. (14), the log-likelihood of the multivariate SNP density
that each observation at time t contributes to, without unnecessary con-
The empirical testing requires the truncation of Eq. (11) so that it en- stant components, is shown as
ables the specification of asset return distribution density conditioned
1 1 n o
on the information set Ωt−1 at time t-1. It is usually assumed that εit is logðSNP Þ ¼ − ln jRt j− ε0t R−1
2 −1 2
t ε t þ ln ∑i¼1 ωi ψi ðxit Þ : ð18Þ
a standardized random variable with zero mean and unit variance. 2 2
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 125

Note that each series in εt in the equation has zero mean and unit Table 1
variance. And series in εt are not independent and have conditional Structural breaks test.

variance-covariance matrix Qt as well as conditional correlation matrix Panel A: Number of breaks

Rt that are defined by a bivariate DCC-GARCH model as in Eqs.(5) and Fuel oil
(10). It should be observed that neither Qt nor Rt is an identity matrix. H0 : L vs. HA : L + 1 F-stat. Scaled F-stat. Critical value
L=0 1.965 33.410⁎⁎ 27.030
A two-step estimation procedure is applied to obtaining estimates of
L=1 1.538 26.151 29.240
the individual GARCH processes with time-varying volatility spillover, CSI 300
conditional correlation matrix and marginal skewness and kurtosis. H0 : L vs. HA : L + 1
First, the individual conditional variance equations are estimated via L=0 2.886 49.062⁎⁎ 27.030
L=1 1.681 28.576 29.240
QMLE assuming Gaussian distribution and standardized innovations
are obtained. Second, the parameters that capture the conditional corre- Panel B: Break dates
lation and other higher order moments are obtained via the maximiza- Futures Break Date Event
Fuel oil March 23, 2016 The occurrence of a terrorist attack in
tion of Eq. (18) over the whole sample.
Belgium on March 22, 2016;
Drastic price drops of the global crude oil
futures markets as well as the Asian fuel oil
4. Empirical results spot market.
CSI 300 May 26, 2015 The occurrence of Chinese stock market
4.1. Data crash.

We collect daily prices of futures contracts of fuel oil traded in
Shanghai Futures Exchange (SHFE), and futures contracts of China Secu-
rities Index (CSI) 300 traded in China Financial Futures Exchange
(CFFEX). Note that each futures contract of fuel oil traded in SHFE is
for 50 t of fuel oil. The sample period is from May 17, 2010 to March
30, 2018. Price series of the first-month trading of the CSI 300 index fu-
Notes: This table reports the result of Bai and Perron (2003)’s sequential structural breaks
test. L denotes the number of determined breaks in the sample. The null hypothesis of the
test is that there are L number of determined breaks in the sample path while the alterna-
tive is that there are L + 1 breaks. A test sequence is applied as L increases. The sequence
stops when the null is not rejected. The critical values at the 5% significance level are re-
ported associated with L. H0, the null hypothesis; HA, the alternative hypothesis. Fuel oil,
the fuel oil futures; CSI 300, the CSI 300 index futures. ** denotes the significance at the
5% level.

tures are excluded from the sample to avoid any unexpected turmoil
arising from the introductory stage of the stock index futures market.
To construct the sample, we only collect daily price observations of
the most nearby futures contracts to ensure the liquidity. The most
nearby contracts are the ones that are closest to the expiration dates
at each calendar month. We switch the most nearby contract to the sec-
ond most nearby one if the trading volume of the former is exceeded by
the latter at the former's contract month. After matching the data series,
we end up with 2055 observations for the whole sample. All data are ob-
tained from Datastream.
Both fuel oil and CSI 300 price series are in the form of natural loga-
rithms. Returns are calculated as the first differences of log price series.
We apply the sequential structural breaks test of Bai and Perron (2003)
to examine the potential structural changes in the conditional means of
fuel oil and CSI 300 return series.10 In the test, we choose the maximum
determined breaks to be five for the testing sequence. The test result in
Table 1 suggests that there is one structural break for each of the full
sample of fuel oil and CSI 300 return series at the 5% level. The structure
break dates are May 26, 2015 for the CSI 300 series and March 23, 2016
for the fuel oil series, respectively. The structure break date for the CSI
300 relates to the occurrence of the Chinese stock market crash in
2015. The structure break date for the fuel oil series relates to dramatic
fall of prices of the global crude oil markets and the Asian fuel oil spot
market on that date, following a serious terrorist attack in Belgium on
March 22, 2016. The attack is perceived to have a significant impact
on the international oil markets since it negatively affects market de-
mand of investing in the international risky instruments.11
We thus split the whole sample into three subsamples based upon
the two identified break dates. In particular, the first subsample (hereaf-
ter referred to as subsample 1) is from May 17, 2010 to May 26, 2015;
the second subsample (hereafter referred to as subsample 2) is from
May 27, 2015 to March 23, 2016; and the third subsample (hereafter re-
ferred to as subsample 3) is from March 24, 2016 to March 30, 2018. The
descriptive statistics of return series for the whole and these subsamples
are shown in Table 2. As can be seen from Table 2, means of the fuel oil
and CSI 300 index futures returns vary correspondingly as structural
break events occur. They reflect the average performance of each mar-
ket during each subsample.12 Before the Chinese stock market crash,
the mean of fuel oil returns is negative whereas the mean of the CSI
300 returns is positive. This suggests that the stock index futures market
performs better than the fuel oil before the crash.
The means of both markets are negative after the crash takes place.
Better performance of both markets is observed in the Subsample 3
given the two positive means, where the stock index futures still per-
forms better than the fuel oil. The stability of the two markets is similar
in both subsamples 1 and 2. It is observed that standard deviation of the
fuel oil returns is substantially higher than that of the CSI 300 in the sub-
sample 3. Finally, non-zero skewness and excess kurtosis are observed
for both markets across the subsamples. This indicates the non-
normality of returns for all the subsamples, as confirmed by the JB
test. Thus the SNP approach is necessary to address the asymmetry
and fat tails of the return distribution.
The result of the unit root test is given in Table 3. According to Panel
A of the table, both the Augmented Dickey-Fuller (ADF) and Phillips-
Perron (PP) tests indicate that across all the subsamples the price series
have one unit root whereas the return series do not. Hence, at each sub-
sample both fuel oil and CSI 300 price series are integrated at order one.
Panel B of Table 3 shows the result of unit root test on full sample of
price and return series allowing for structural breaks. First, the ADF test
allowing for break dates detected by Bai and Perron test in shows that
both fuel oil and CSI 300 futures prices have one unit root while neither
of returns does. Second, the ADF test which detects break dates in both
intercept and trend via maximized F statistic suggests similar result.
Thus, the result of full sample is consistent with subsamples, suggesting
that both fuel oil and CSI 300 index prices are integrated at order one
even if structural breaks exist.
Since both price series have the same integration order, they may
well be cointegrated. The cointegration is tested by the PH test under
the consideration of time-varying cointegrating coefficient.

10
The test is conducted to assess the structural breaks of the coefficients of the VECM as
in Eqs. (2) and (3) that specifies conditional means of both fuel oil and CSI 300 index fu-
tures return series. The coefficients under test include intercepts and all coefficients of
lagged return series. The lag order is determined by the AIC. Hence, the detected structural
12
breaks are related to both location and slope of the VECM. Note that the magnitude of means is relatively small since return data are calculated as
11
see e.g. www.cnpc.com.cn, accessed in May 2018. daily changes of logarithmic prices.
126 Y. Hou et al. / Energy Economics 83 (2019) 119–143

Table 2
Descriptive statistics of daily returns.

Full sample Subsample 1 Subsample 2 Subsample 3

Fuel oil CSI 300 Fuel oil CSI 300 Fuel oil CSI 300 Fuel oil CSI 300

Mean −2.27 × 10−5 1.72 × 10−4 −2.40 × 10−4 5.02 × 10−4 −2.19 × 10−3 −2.32 × 10−3 1.41 × 10−3 3.74 × 10−3
Median −1.73 × 10−4 −4.53 × 10−4 2.89 × 10−4 −5.51 × 10−4 2.712 × 10−3 −9.86 × 10−5 −1.01 × 10−4 4.39 × 10−3
Maximum 0.185 0.095 0.104 0.059 0.089 0.095 0.185 0.035
Minimum −0.189 −0.105 −0.133 −0.104 −0.100 −0.105 −0.189 −0.057
Std. dev. 0.019 0.015 0.015 0.014 0.025 0.029 0.024 0.009
Skewness 0.447 −0.475 −0.238 −0.029 0.042 −0.342 1.011 −0.847
Kurtosis 20.947 11.766 14.445 8.056 5.129 5.360 24.541 9.298
JB 2.76 × 104⁎⁎⁎ 6.65 × 103⁎⁎⁎ 7.17 × 103⁎⁎⁎ 1.40 × 103⁎⁎⁎ 40.847⁎⁎⁎ 54.336⁎⁎⁎ 1.03 × 104⁎⁎⁎ 933.965⁎⁎⁎

Notes: This table reports the descriptive statistics of daily logarithmic returns of the fuel oil and CSI 300 futures. The daily returns are calculated as the first differences of daily logarithmic
prices. Full sample is from May 17, 2010 to March 30, 2018; Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March 23, 2016; Subsample 3 is from
March 24, 2016 to March 30, 2018. Std. Dev., standard deviation; JB, the Jarque-Bera test statistic for normality. *** denote significance at the 1% level.

4.2. Time-varying cointegration
In this section, we conduct cointegration test associated with Eq. (1)
t samples. In contrast, the existence of cointegration is rejected for all the
given the time varying cointegrating coefficient βð Þ. According to Park
n three subsamples in the context of time-invariant cointegrating coeffi-
(1992), Park and Hahn (1999) and Park and Zhao (2010), the canonical
cointegration regression (CCR) method is used to obtain an efficient es-
timator and a valid inferential basis for the coefficients of Eq. (1).
Park and Hahn (1999) employ the superfluous regression approach
to test the null hypothesis of the time-varying coefficient cointegration
against the alternative of the spurious regression with non-stationary
innovations (Park and Zhao, 2010). The test statistic is
RSSTVC −RSSsTVC
τ ¼ ð19Þ
ω2
where RSSTVC and RSSsTVC are the sum of squared residuals from the CCR
for Eq. (1) and the same regression augmented with s additional super-
fluous regressors, respectively. ω ∗ 2 is the conditional long-run variance
of the regression errors of Eq. (1). Under the null hypothesis of a true
time-varying cointegration model, the limit distribution of τ ∗ is a chi-
square distribution with s degree of freedom. Alternatively, the null hy-
pothesis of the validity of the time-invariant coefficient cointegration
t
model, that is, βð Þ in Eq. (1) is static over time, is tested by the test sta-
n
tistic as below
RSSFC −RSSsFC
τ1 ¼ : ð20Þ
ω2
where RSSFC and RSSsFC are the sum of squared residuals from the CCR es-
timation of Eq.(1) with the time-invariant cointegrating coefficient and
the same regression augmented by s additional superfluous regressors,
respectively. ω ∗ 2 is the conditional long-run variance of the regression
errors of Eq. (1). The limit distribution of τ1∗ is the chi-square distribu-
tion with s degree of freedom under the null. For details of time varying
cointegration test we refer to Appendix C.
Moreover, the null hypothesis of the time-invariant cointegration
model against the alternative of the time-varying model is tested with
the null hypothesis that all the coefficients governing time variation of
t U.S. markets and Reboredo and Ugolini (2016) on the international
cointegrating coefficient βð Þ are zero for a specific k. The test statistic
n
follows a chi-square distribution with the number of restrictions as de-
gree of freedom.
The result of the PH cointegration test is shown in Table 4. Following
Park and Hahn (1999), Park and Zhao (2010) and Joo and Park (2017),
the number of additional superfluous regressors, that is, s, augmenting
the CCR with time varying and static cointegrating coefficients is chosen
to be 4 for the alternative hypothesis. Specifically, the superfluous regres-
sors contain t, t2, t3 and t4 simultaneously. In Panel A of the table, the va-
lidity of the cointegration equation with the time-varying cointegrating
coefficient is not rejected, suggesting cointegration of the fuel oil and
CSI 300 futures prices exists under the context that the cointegrating re-
lation changes over time. The evidence is consistent across the three sub-
cient. This result is agreed by the Johansen cointegration test. Hence,
there is no cointegration if assuming cointegrating relation is static. How-
ever, the time-varying feature of cointegrating relationship is supported
by the result in Panel D of the table, where the null hypothesis that the
cointegrating coefficient is time-invariant is rejected.
Furthermore, Panel E of the table shows the result of PH test with al-
ternative number of additional superfluous regressors augmenting the
CCR of null hypothesis. In particular, we choose alternative s to be 1, 2
and 3, respectively. Smaller s is considered since testing power would be
enhanced due to less difference between CCR of null hypothesis and aug-
mented one of alternative hypothesis. With smaller s, the misspecification
of the augmented CCR by those additional regressors is mitigated. Under
such context, we assess whether the result of Panels A and B still holds.
It is apparent to see that for each subsample, the cointegration allowing
for time varying cointegrating coefficient is not rejected. In contrast, the
cointegration with static coefficient is rejected. The result is consistent
with Panels A and B. Hence, our result of cointegration test is robust in
terms of various number of superfluous regressors.
We specify a VECM for returns of the fuel oil and CSI 300 futures as in
Eqs. (2) and (3), where the lagged error correction term (ECT) is
governed by time-variant cointegrating coefficient.13
The result of VECM is presented in Table 5. As can be seen from the
table, the error correction coefficient of the fuel oil market is significant
for the subsample 1 whereas this is not the case in the stock index fu-
tures market. This suggests that the stock index futures market leads
the fuel oil market in the long term before the Chinese stock market
crash. Similar finding holds right after the crash occurs. After a while
from the crash, in the subsample 3, there is a bilateral lead-lag relation
in the long run between the two markets. However, the stock index fu-
ture prices still lead the fuel oil counterparts, provided that the error
correction coefficient of the latter is larger than the former in scale.
The result is different from the evidence on the mean spillover between
stock and crude oil markets by Awartani and Maghyereh (2013) on the
Gulf Cooperation Council (GCC) countries, Chang and Yu (2013) on the
markets. However, the result is consistent with Mensi et al. (2013)
who find the stock prices have a stronger impact on the crude oil prices
than the reverse way in U.S. in the interdependency of conditional
means. The evidence is in line with Li et al. (2017) who find the mean
spillover is from energy stock index to fuel oil spot and futures prices
but not the other way around. Our result also aligns with Henriques
and Sadorsky (2008), Apergis and Miller (2009) and Sukcharoen et al.
13
The null hypothesis that the estimated time-varying cointegrating coefficients have
zero mean is rejected at 1% level for all three subsamples.
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 127

Table 3
Unit root tests.

ADF (price) ADF (return) PP (price) PP (return)

Panel A: Unit root test, subsamples

Subsample 1: May 17, 2010 to May 26, 2015
Fuel oil −0.651 −13.678⁎⁎⁎ −0.656 −38.738⁎⁎⁎
CSI 300 1.271 −12.137⁎⁎⁎ 0.918 −35.585⁎⁎⁎
Subsample 2: May 27, 2015 to March 23, 2016
Fuel oil −2.156 −15.821⁎⁎⁎ −2.105 −15.838⁎⁎⁎
CSI 300 −2.231 −5.284⁎⁎⁎ −2.393 −13.078⁎⁎⁎
Subsample 3: March 24, 2016 to March 30, 2018
Fuel oil −1.698 −23.598⁎⁎⁎ −1.700 −23.588⁎⁎⁎
CSI 300 −1.157 −7.516⁎⁎⁎ −1.079 −23.133⁎⁎⁎

ADF with breaks (price) ADF with breaks (return) ADF – Max F test (price) ADF – Max F test (return)

Panel B: Unit root test, full sample containing structural breaks

Fuel oil −2.935 −46.504⁎⁎⁎ −4.459 −46.660⁎⁎⁎
CSI 300 −0.941 −9.757⁎⁎⁎ −4.514 −9.809⁎⁎⁎

Notes: This table reports results of unit root test for prices and returns of the fuel oil and CSI 300 index futures. Panel A reports results of the Augmented Dickey-Fuller (ADF) and Phillips-
Perron (PP) unit root tests for price and return series of the fuel oil and CSI 300 futures for the three subsamples. Panel B reports results of unit root test with structural breaks for full sample
of prices and returns. ADF (price), ADF test statistic for price level; ADF (return), ADF test statistic for return level. PP (price), PP test statistic for price level; PP (return), PP test statistic for
return level. ADF with breaks (price), ADF test statistic with structural breaks reported in Table 1 for price level; ADF with breaks (return), ADF test statistic with structural breaks reported in
Table 1 for return level; ADF – Max F test (price), ADF test statistic with structural breaks for full sample of price series, where structural breaks are detected by maximized F statistic as-
suming breaks in both intercept and trend; ADF – Max F test (return), ADF test statistic with structural breaks for full sample of return series, where structural breaks are detected by max-
imized F statistic assuming breaks in both intercept and trend. *** denotes significance at the 1% level.

(2014), suggesting that oil returns have weak predictive power for stock
returns. A surmise arises from the result that the stock index futures
market plays a leading role in the information transmission process
throughout the subsamples. This will be further analysed by the time-
varying spillover in the DCC-GARCH model with SNP approach.
According to Panel B of Table 5, the multivariate Portmanteau auto-
correlation test suggests that there is no autocorrelation in the residuals
of estimated VECM across the subsamples. It should be noted that the
multivariate Portmanteau autocorrelation test tests the null hypothesis
that the vector of estimated residuals of the VECM in Eqs. (2) and (3),
that is, ^e1;t and ^e2;t , are not autocorrelated up to lag order 6. According
to Lütkepohl (1991), in the multivariate Portmanteau autocorrelation
test, Box-Pierce and Ljung-Box Q statistics for the bivariate model are
combined to yield a single test statistic.
The univariate Ljung-Box test on each residual series across the sub-
samples suggests that residual series of both fuel oil and CSI 300 futures
are free of autocorrelation except for CSI 300 futures in Subsample 3.
Hence, we further employ Durbin Watson and Breusch Godfrey tests
to assess autocorrelation in each residual series. As can be seen from
Panel B, both tests suggest that there is no autocorrelation in the

Table 4
Cointegration test under time-invariant and time-varying cointegrating coefficients.

Subsample 1 Subsample 2 Subsample 3

k=3 k=3 k=4

Panel A: Time-varying coefficient, s = 4

τ∗ 8.256 5.199 8.409

Panel B: Time-invariant coefficient, s = 4

τ1∗ 158.060⁎⁎ 31.782⁎⁎ 56.498⁎⁎

Panel C: Johansen cointegration test

Trace (r = 0) 15.262 9.123 7.435
Panel D: H0 : αk, 2 = αk, 3 = … = αk, 2(k+1) = 0 k=3 k=3 k=4
χ2(2k + 1) 2040.990⁎⁎ 453.926⁎⁎ 1128.898⁎⁎

Panel E: Time varying and time invariant coefficients under different s

τ∗ k=3 k=3 k=4
s=1 −0.030 2.229 0.429
s=2 5.015 5.546 5.565
s=3 7.445 5.619 5.948
τ1∗ k=3 k=3 k=4
s=1 96.973⁎⁎ 4.824⁎⁎ 19.457⁎⁎
s=2 154.684⁎⁎ 10.207⁎⁎ 46.530⁎⁎
s=3 155.510⁎⁎ 31.463⁎⁎ 46.815⁎⁎

Notes: This table shows results of the Park and Hahn (1999) test and Johansen cointegration test. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to
March 23, 2016; Subsample 3 is from March 24, 2016 to March 30, 2018. τ ∗ and τ1∗ are calculated by Eqs. (19) and (20), respectively. τ ∗and τ1∗ follow a χ2 distribution with degree of
freedom equal to the number of superfluous regressors augmenting the null hypothesis equation. s denotes the number of superfluous regressors and s is chosen to be 4 for tests in Panels
t
A and B. The superfluous regressors are t, t2, t3 and t4. k in Panels A, D and E refers to the number of pairs of trigonometric polynomial functions forβð Þ. Critical value at the 5% level under χ2
n
∗ ∗
(4) distribution for τ and τ1 is 9.488. Trace is the Johansen Trace test statistic. r is the number of cointegrating equations. The null hypothesis of Trace test is the number of cointegration
equations is at most r. Critical value at the 5% level for Trace statistics is 15.495. Panel D tests the null hypothesis that the cointegrating coefficient is constant. αk, 2, αk, 3, …, αk, 2(k+1) are
t
coefficients that define time variation of βð Þ for a specific k. χ2(2k + 1) indicates the test statistic follows a χ2 distribution with degree of freedom equal to 2k + 1 where k is the same to
n
the one in Panel A. Panel E reports the PH test statistics given alternative number of superfluous regressors augmenting the null hypothesis equation. For each subsample, s is chosen to be
1, 2 and 3, respectively. s = 1, the superfluous regressors only include t; s = 2, the superfluous regressors include both t and t2; s = 3, the superfluous regressors include t, t2 and t3. Critical
values at the 5% level under χ2(1), χ2(2) and χ2(3) distributions for τ ∗ and τ1∗ are 3.841, 5.991 and 7.815, respectively. ** denotes significance at the 5% level.
128 Y. Hou et al. / Energy Economics 83 (2019) 119–143

Table 5
The VECM with time-varying cointegrating coefficients.

Variables Subsample 1 Subsample 2 Subsample 3

Δot Δpt Δot Δpt Δot Δpt

Panel A: Model estimates

ut−1 −0.049⁎⁎⁎ 0.003 0.294⁎⁎⁎ 0.012 0.107⁎⁎⁎ −0.014⁎
(0.0086) (0.0076) (0.0555) (0.0682) (0.0203) (0.0077)
Δot−1 – – 0.012 0.061 – –
(0.0729) (0.0896)
Δot−2 – – 0.038 −0.038 – –
(0.0699) (0.0859)
Δpt−1 – – 0.038 0.129⁎ – –
(0.0583) (0.0717)
Δpt−2 – – −0.066 −0.203⁎⁎⁎ – –
(0.0580) (0.0713)

Panel B: Residual diagnosis

Portmanteau adjusted Q(Arouri et al., 2012) 14.449 21.455 32.057
LB(Arouri et al., 2012) 4.011 3.632 10.549 5.578 5.399 15.179⁎⁎
Durbin-Watson 1.973 1.949 1.941 1.998 1.900 2.000
Breusch-Godfrey (Arouri et al., 2012) 3.986 3.968 5.173 0.225 4.897 9.715
LB2(Arouri et al., 2012) 107.376⁎⁎⁎ 52.796⁎⁎⁎ 2.278 37.441⁎⁎⁎ 5.467 19.764⁎⁎⁎
ARCH (Arouri et al., 2012) 71.182⁎⁎⁎ 53.754⁎⁎⁎ 2.573 30.699⁎⁎⁎ 4.755 18.685⁎⁎⁎

Notes: This table reports estimation result of the VECM defined in Eqs.(2) and (3). Δot and Δpt denote returns of the fuel oil and CSI 300 futures at date t, respectively. ut−1 denotes the
t
lagged error correction term defined in Eq. (1), incorporating the time-varying cointegrating coefficientβð Þ. Note that k = 3 for subsamples 1 and 2 and k = 4 for subsample 3. The optimal
n
lag order (p) of the underlying vector auto-regression (VAR) is chosen by Akaike Information Criteria (AIC). p = 0 for subsamples 1 and 3 while p = 2 for subsample 2. Portmanteau Ad-
justed Q(Arouri et al., 2012) denotes the adjusted Q statistic up to lag order 6 of the multivariate Portmanteau autocorrelation test for residuals of model system. Q statistic is adjusted by the
sample size. The test statistic follows a Chi-square distribution with 24 degrees of freedom. Durbin-Watson denotes the Durbin Watson test statistic. Values of test statistic ranging from 1.7
to 2.0 suggest no autocorrelation. Breusch-Godfrey (Arouri et al., 2012) denotes the Breusch Godfrey test statistic up to lag order 6. The test statistic follows a Chi-square distribution with
degree of freedom equal to 6. The null hypothesis of the test is that there is no autocorrelation up to lag order 6 in time series. LB(Arouri et al., 2012) and LB2(Arouri et al., 2012) are the
Ljung-Box Q statistics of residuals and its squares up to lag order 6, respectively. ARCH (Arouri et al., 2012) denotes the test statistic for the test of the ARCH effect up to lag order 6. The test
statistic follows a Chi-square distribution. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March 23, 2016; Subsample 3 is from March 24, 2016 to
March 30, 2018. Figures in the parentheses are standard errors. ***, **, and * denote significance at the 1%, 5% and 10% levels, respectively.

residuals of all the subsamples, especially for residuals of CSI 300 futures
in Subsample 3. Therefore, the estimation of VECM does not suffer the
autocorrelation problem.
Meanwhile, heteroscedasticity is detected in the residuals of both
markets, especially in those of the stock index futures market across
the three subsamples. Volatility clustering significantly exists in the
fuel oil futures market before the stock market crash. The conditional
heteroscedasticity will be accounted for in the variance equations of
the DCC-GARCH model with SNP approach.
Fig. 1 depicts the movements of time varying cointegrating coeffi-
cient in the three subsamples. The 95% confidence interval bands for
the coefficient are also shown. Moving patterns differ across those sub-
sample periods. The increasing or decreasing trend of the coefficient
could be explained as below. As suggested by Creti et al. (2013),
Sadorsky (2014) and Li et al. (2017), when fuel oil production is rela-
tively stable, the relationship between fuel oil and stock markets is de-
termined by the level of financialization of fuel oil market which
hinges on a competition between real and speculative demands of fuel
oil product. Specifically, when speculative demand dominates, fuel oil
market shows more financial characteristics, which results from the
high degree of cash adequacy or excess liquidity in the market. In such
a situation, fuel oil prices reflect speculations in the market rather
than actual economic needs. The high degree of financialization of the
fuel oil market tightens the relationship between fuel oil and stock mar-
kets, thus pertaining to high cointegrating coefficient as it mirrors the
long-run relationship between the two markets.
As can be seen from this figure, Subsample 1 has an increasing trend
of cointegrating coefficient, followed by a decreasing one. The patterns
imply that during an earlier period before the stock market crash in
China took place in May 2015, excess liquidity was available for the
fuel oil market, making the market more financialised and resulting in
higher cointegrating coefficient. The financialization of the oil market
is alleviated afterwards due to the domestic oil price control policy im-
plemented by the Chinese government. For example, the domestic oil
prices are adjusted if the average price of international crude oil changes
by N4% in 22 consecutive working days. This helps to make the local oil
markets more stable, more commercialised and less financialised.
Briefly, this policy imposed a delayed adjustment for domestic oil prices
by referencing the international oil prices. Such policy aims to control
the financialization of domestic oil markets (Li et al., 2017). Therefore,
one can expect that decreasing cointegrating coefficient results from
the effect of price control policy.
In Subsample 2, the decreasing coefficient at the beginning, suggest-
ing the weakened relationship between fuel oil and stock markets, re-
sults from stock market crisis where economic decline led to the
decreased speculative demand and the lowered financialization of oil
market. As the stock market recovered later, more speculative funds
flew into the fuel oil market, resulting in heightened financialization
and cointegrating coefficient. However, a decreasing trend of coefficient
follows due to the intervention imposed by the price control policy.
In Subsample 3 the cointegrating coefficient is negative. Aligning
with Li et al. (2017), the negative long-run relationship might result
from a tougher domestic oil price control policy by the Chinese govern-
ment. This is due to the break event that took place in March 2016, as
showed in Table 1. In the aftermath of the event, the Asian fuel oil
spot market suffered dramatic drops. To cope with such shock, the Chi-
nese government imposed even more stringent intervention on the do-
mestic fuel oil prices. This action further impeded the effects of
fundamental economic factors such as oil production, real demand
and speculative demand on fuel oil prices, leading to the mismatch be-
tween the market and the status of economy. Thus a negative relation
between fuel oil and stock markets can be expected. The negativity of
the coefficient mitigates later with some reversions. This might be due
to the fact that the Chinese government's intervention became less re-
strictive as the fuel oil market recovered.
The differing patterns of cointegrating coefficient among the three
subsamples might be the consequence of structural break events such
as stock market crash and oil market shock. These events affect the de-
termining factors on increasing or decreasing trend of the long-run rela-
tionship, including speculative demand, degree of financialization and
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 129

Time varying cointegrating coefficients, subsample 1

.16

.15

.14

.13

.12

.11

.10

.09

.08
2/28/11 2/13/12 1/28/13 1/13/14 12/29/14

Time varying cointegrating coefficients, subsample 2

.44

.43

.42

.41

.40

.39

.38
7/27/15 9/28/15 11/30/15 2/1/16

Time varying cointegrating coefficients, subsample 3

-.48

-.50

-.52

-.54

-.56

-.58

-.60
7/11/16 11/28/16 4/17/17 9/4/17 1/22/18

Fig. 1. Time varying cointegrating coefficients. Notes: This figure shows the time varying cointegrating coefficients, which are defined by the Fourier flexible form (FFF) functions with kth
order. The parameters governing the coefficients are estimated by the CCR. 95% confidence interval bands of the coefficients are also shown. Subsample 1 is from May 17, 2010 to May 26,
2015; Subsample 2 is from May 27, 2015 to March 23, 2016; and Subsample 3 is from March 24, 2016 to March 30, 2018.
130 Y. Hou et al. / Energy Economics 83 (2019) 119–143

Table 6
The DCC-GARCH-SNP model with time-invariant spillover.

Coefs. Subsample 1 Subsample 2 Subsample 3

i=1 i=2 i=1 i=2 i=1 i=2

Panel A: Conditional variances

θ0i 1.06 × 10–6⁎⁎⁎ 3.70 × 10–6⁎⁎⁎ 7.26 × 10−5 5.77 × 10–5⁎⁎ 5.64 × 10–5⁎⁎⁎ 8.14 × 10–6⁎⁎⁎
(2.18 × 10−7) (8.91 × 10−7) (5.62 × 10−5) (2.78 × 10−5) (1.46 × 10−6) (3.04 × 10−7)
θ1i 0.054⁎⁎⁎ 0.038⁎⁎⁎ 0.068 0.092⁎⁎⁎ 0.210⁎⁎⁎ 0.045⁎⁎⁎
(0.0027) (0.0060) (0.0473) (0.0355) (0.0154) (0.0064)
θ2i 0.949⁎⁎⁎ 0.939⁎⁎⁎ 0.750⁎⁎⁎ 0.858⁎⁎⁎ 0.684⁎⁎⁎ 0.948⁎⁎⁎
(0.0019) (0.0094) (0.1606) (0.0574) (0.0224) (0.0070)
spoi −0.002⁎ 0.002 0.029 −0.044⁎⁎⁎ −0.041⁎⁎⁎ −1.46 × 10−4
(0.0012) (0.0011) (0.0233) (0.0157) (0.0107) (0.0002)

Panel B: Conditional correlation

λ1 0.114⁎⁎⁎ 0.077⁎⁎⁎ 0.071⁎⁎
(0.0140) (0.0113) (0.0281)
λ2 0.706⁎⁎⁎ 0.950⁎⁎⁎ 0.901⁎⁎⁎
(0.0534) (0.0111) (0.0626)

Panel C: SNP distribution

s1 0.037 −0.300 0.032
(0.1390) (0.6704) (0.2788)
s2 0.484 −0.515 −0.358
(0.3484) (0.8795) (0.6507)
k1 3.983⁎⁎⁎ 5.583 3.452⁎
(1.0394) (5.1710) (1.8604)
k2 6.631⁎⁎ 6.670 7.310
(2.9224) (6.8222) (6.1222)

Panel D: Residual diagnosis

Log L 10,311.240 1371.560 4033.935
LB2(Arouri et al., 2012) 4.938 8.919 1.072 1.456 1.996 4.895
ARCH (Arouri et al., 2012) 4.796 8.981 1.091 1.670 1.923 5.206

Notes: This table reports the estimation results of the bivariate DCC-GARCH-SNP model with the time-invariant spillover effects based upon Eqs. (6), (9), (10), (12) and (13). Coefs. denotes
coefficients. i = 1 refers to the conditional variance equation of fuel oil while i = 2 refers to the conditional variance equation of CSI 300. spoi is equivalent to δi, k (i = 1,2) in Eq. (9) where
the order K is 0; hence it refers to the time-invariant spillover effects. Log L, maximized log-likelihood of the model. LB2(Arouri et al., 2012) is the Ljung-Box Q statistics of squared stan-
dardized residuals up to lag order 6. ARCH (Arouri et al., 2012) denotes the test statistic for testing the ARCH effect up to lag order 6. Subsample 1 is from May 17, 2010 to May 26, 2015;
Subsample 2 is from May 27, 2015 to March 23, 2016; Subsample 3 is from March 24, 2016 to March 30, 2018. Figures in the parentheses are standard errors. ***, **, and * denote signif-
icance at the 1%, 5% and 10% levels, respectively.

price control policy. The patterns of cointegrating coefficient revealed in
Fig. 1 are consistent with dynamic correlations of returns depicted in
Fig. 3 below, where positive correlations are observed for Subsamples
1 and 2 while negative ones are observed for Subsample 3.
4.3. Volatility spillover
4.3.1. Time-invariant spillover
The estimation result of the DCC-GARCH model with SNP approach
and time-invariant spillover between fuel oil and CSI 300 markets is
shown in Table 6. Note that time-invariant spillover effects are captured
by the parameter spoi (i = 1,2), which is equivalent to δi, 0 (i = 1,2) in
Eq. (9) when the order K is chosen to be 0. As can be seen from the table,
volatility clustering exists in both markets across the three subsamples,
where the individual variances are driven by the past information.
The sum of θ11 and θ21 is slightly over 1 in Subsample 1. To justify this
result, we calculate the long run average variance of the fuel oil returns
using the equation in Section 3.2 in the context of static spillover. The cal-
culated variance is 0.1249 which is positive. This suggests the existence of
the long run average variance of the fuel oil returns in Subsample 1. More-
over, we test the stationarity of estimated conditional variance series of
fuel oil in Subsample 1. The Kwiatkowski-Phillips-Schmidt-Shin (KPSS)
test and the Elliott-Rothenberg-Stock (ERS) test are employed. Both test
statistics suggest the variance series does not have a unit root.14 The series
is stationary. Therefore, estimation result of θ11 and θ21 is justified.
In Subsample 1, spo1 is significant at 10% level whereas spo2 is not
significant at any conventional level. Hence, volatility spillover from
14
KPSS test statistic is 0.094 and ERS test statistic is 4.523.
CSI 300 market to fuel oil market but not vice versa15. Similar evidence
is found in Subsample 3. In contrast, in Subsample 2, spo1 is not signifi-
cant at any level whereas spo2 is significant at the 1% level. Volatility
spillover exists only from fuel oil market to CSI 300 market but not the
other way around soon after the stock market crash. In addition, all
the significant spillover effects are estimated to be negative, suggesting
they are stabilising effects.
We find patterns of information transmission in terms of time-
invariant spillover between the two markets vary across different pe-
riods. Information transmits only from the stock index futures market
to fuel oil futures market in the pre-crash period, suggesting a leading
informational role of the former.
This is also the case in the aftermath of market crash where impacts
of the crash have been impounded for a while. The result implies that
15
In Subsample 1, statistical significance of spo1 at 10% level suggests that we have 90%
confidence to gauge that the true volatility spillover from the CSI 300 to fuel oil futures
markets is non-zero. Such confidence level is acceptable since sample size of Subsample
1 is relatively large (over 1000 observations). It is generally argued that narrowed confi-
dence level could be accepted to maintain testing power when sample size is relatively
large (Koop, 2013; Tsay, 2010). Hence, significance of spo1 at the 10% level is deemed ap-
propriate. On the other hand, under the context of 5% significance level, spo1 is not signif-
icant. This means there is no static volatility spillover between the two markets in
Subsample 1. However, the finding would not affect the major contribution of this paper
since our focus is time varying volatility spillover rather than the static one. The latter is
showed in Table 6 for comparison purpose only. Even though there is no volatility spillover
at 5% level, the finding of time varying spillover in Section 4.3.2 suggests there is bidirec-
tional spillover where the strength from the CSI 300 index to fuel oil futures markets is
higher than the reverse way across the subsamples. It implies that taking into account time
varying feature yields new evidence compared to traditional static coefficient. The conclu-
sion is similar to the context of 10% significance level. Hence neither 10% nor 5% level alters
the conclusion of this paper.
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 131

Table 7
The DCC-GARCH-SNP model with time-varying spillover.

Coefs. Subsample 1 Subsample 2 Subsample 3

i=1 i=2 i=1 i=2 i=1 i=2

Panel A: Conditional variances

θ0i 4.25 × 10–6⁎⁎⁎ 6.51 × 10–6⁎⁎⁎ 2.54 × 10−5 6.60 × 10–5⁎⁎⁎ 4.89 × 10–5⁎⁎⁎ 3.61 × 10–5⁎⁎⁎
(3.65 × 10−7) (1.45 × 10−7) (1.91 × 10−5) (1.68 × 10−5) (1.00 × 10−5) (3.87 × 10−6)
θ1i 0.087⁎⁎⁎ 0.025⁎⁎⁎ 0.013 0.061⁎⁎⁎ 0.332⁎⁎⁎ 0.292⁎⁎⁎
(0.0055) (0.0063) (0.0271) (0.0224) (0.0117) (0.0639)
θ2i 0.887⁎⁎⁎ 0.932⁎⁎⁎ 0.854⁎⁎⁎ 0.831⁎⁎⁎ 0.576⁎⁎⁎ 0.230⁎⁎⁎
(0.0052) (0.0128) (0.0565) (0.0119) (0.0146) (0.0376)
δi, 0 −2.201⁎⁎⁎ 2.477⁎⁎⁎ 16.195⁎⁎⁎ −10.583⁎⁎⁎ −39.524⁎⁎⁎ 1.183⁎⁎⁎
(0.0115) (0.7663) (5.2290) (0.4049) (0.1134) (0.0219)
δi, 1 5.200⁎⁎⁎ −5.641⁎⁎⁎ −36.981⁎⁎⁎ 24.595⁎⁎⁎ 92.297⁎⁎⁎ −2.614⁎⁎⁎
(0.0184) (1.7480) (11.9244) (0.9848) (0.2651) (0.0317)
δi, 2 −5.066⁎⁎⁎ 5.273⁎⁎⁎ 35.186⁎⁎⁎ −23.742⁎⁎⁎ −88.775⁎⁎⁎ 2.288⁎⁎⁎
(0.0212) (1.6288) (11.2760) (0.9260) (0.3238) (0.0309)
δi, 3 3.010⁎⁎⁎ −2.788⁎⁎⁎ −19.273⁎⁎⁎ 13.309⁎⁎⁎ 46.841⁎⁎⁎ −1.100⁎⁎⁎
(0.0098) (0.8525) (6.1379) (0.5792) (0.2581) (0.0018)
δi, 4 −0.924⁎⁎⁎ 0.746⁎⁎⁎ 5.460⁎⁎⁎ −3.721⁎⁎⁎ −10.898⁎⁎⁎ 0.268⁎⁎⁎
(0.0132) (0.2195) (1.7108) (0.2347) (0.1270) (0.0223)

Panel B: Conditional correlation

λ1 0.049⁎⁎⁎ 0.073⁎⁎⁎ 0.328⁎⁎⁎
(0.0092) (0.0111) (0.0311)
λ2 0.883⁎⁎⁎ 0.951⁎⁎⁎ 0.546⁎⁎⁎
(0.0330) (0.0120) (0.0651)

Panel C: SNP distribution

s1 −0.065 −0.147 −0.042
(0.1585) (0.9380) (0.2339)
s2 0.555 1.129 −0.292
(0.3824) (1.6878) (0.5301)
k1 4.056⁎⁎⁎ 9.899 3.865⁎⁎
(1.2374) (14.3305) (1.6539)
k2 7.500⁎⁎ 9.106 7.991
(3.5213) (13.4574) (6.6877)

Panel D: Residual diagnosis

Log L 10,348.002 1385.326 4050.131
LB2(Arouri et al., 2012) 3.264 9.358 2.602 3.221 1.364 8.482
ARCH (Arouri et al., 2012) 3.151 9.547 2.457 3.440 1.309 8.223

Panel E: Likelihood ratio test

LR 73.524⁎⁎ 27.532⁎⁎ 32.393⁎⁎

Notes: This table reports the estimation results of the bivariate DCC-GARCH-SNP model with the time-varying spillover effects based upon Eqs. (6), (9), (10), (12) and (13). Coefs. denotes
coefficients. i = 1 refers to the conditional variance equation of fuel oil while i = 2 refers to the conditional variance equation of CSI 300. δi, k (i = 1,2) refers to the time-varying volatility
spillover effects in Eq. (9) where the order K is 4. Log L, maximized log-likelihood of the model. LB2(Arouri et al., 2012) is the Ljung-Box Q statistics of squared standardized residuals up to
lag order 6. ARCH (Arouri et al., 2012) denotes the test statistic for testing the ARCH effect up to lag order 6. LR denotes the log-likelihood ratio test statistic following a Chi-square distri-
bution with degree of freedom equal to 8. The null hypothesis of likelihood ratio test in Panel E is that the DCC-GARCH-SNP model with time-invariant spillover is valid, that is, δi, 1 = δi, 2 =
δi, 3 = δi, 4 = 0 in Eq. (9). The critical value at the 5% level is 15.507. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March 23, 2016; Subsample 3 is
from March 24, 2016 to March 30, 2018. Figures in the parentheses are standard errors. ***, **, and * denote significance at the 1%, 5% and 10% levels, respectively.

the pricing dynamics of fuel oil futures market hinges on performance of
the Chinese A-share market during the relatively stable periods. The re-
sult, despite of disagreeing with the spillover running from global crude
oil to stock markets (Chang and Yu, 2013; Arouri et al., 2012; Bouri,
2015; Awartani and Maghyereh, 2013), consists with Li et al. (2017)
who find energy stock market leads the fuel oil futures market in the
volatility transmission in China. Moreover, the evidence on static vola-
tility spillover in the relatively tranquil periods is in line with Mensi
et al. (2013) who find the S&P 500 index plays a dominant role in the
volatility transmission process with international crude oil markets dur-
ing the period from 2000 to 2011. In addition, the evidence aligns with
the suggestion revealed by Chen et al. (1986), Huang et al. (1996), Lee
et al. (2012) and Chang et al. (2013) that shocks of global crude oil mar-
kets have inferior ability to affect volatility dynamics of stock markets.
Nonetheless, it is found that within the period around the market
crash event, the fuel oil market leads the stock index futures counterpart
in the information transmission process. The reason might be malfunc-
tion of the index futures market during the crisis. However, the finding
is not consistent with Table 5 suggesting stock index futures market
leads the fuel oil one in the long run in the subsample 2. Hence, further
investigation on the behaviour of volatility spillover is needed.
Panel B of Table 6 suggests that correlation between the fuel oil and
stock index futures markets is conditioned on the past shocks and own
lagged values, across the three subsamples, given significant estimates
of λ1 and λ2. In Subsample 2, the sum of the estimates of λ1 and λ2 is
larger than one. We justify this result by calculating eigenvalues of esti-
mated Qt in Eq. (10) across time to check whether positive definiteness
of Qt holds for that subsample. Note that positive definiteness of Qt re-
quires all the eigenvalues to be positive over time. There are two time
series of eigenvalues of Qt. The minimum value of one series is 0.125
and that of the other series is 0.440. Hence, all the figures of eigenvalues
are positive. The positive definiteness of Qt is ensured even though λ1 +
λ2 N 1 in Subsample 2.
Moreover, the SNP approach significantly captures the excess kurto-
sis of return distribution in Subsamples 1 and 3, as shown in Panel C.
Skewness parameters are estimated but none of them is significant. It
suggests asymmetry of distribution might not be a significant obstacle
for model estimation.
It should be noted that estimates of marginal skewness and kurtosis
are indicative of the first advantage of SNP approach described in
Section 3.2. That is, by means of this approach the marginal third and
fourth moments of individual time series can be captured in a
132 Y. Hou et al. / Energy Economics 83 (2019) 119–143

Table 8
Descriptive properties of time-varying spillover.

Mean Median Std.Dev Max Min t-ratio

Subsample 1
CSI → Fuel oil: spo1, t 0.022 0.014 0.038 0.092 −0.025 13.976⁎⁎⁎
(21.289)⁎⁎⁎
Fuel oil → CSI: spo2, t 0.005 −0.002 0.026 0.120 −0.022
(6.361)⁎⁎⁎

Subsample 2
CSI → Fuel oil: spo1, t 0.114 0.087 0.137 0.650 −0.021 5.692⁎⁎⁎
(12.236)⁎⁎⁎
Fuel oil → CSI: spo2, t 0.051 0.051 0.088 0.205 −0.123
(8.442)⁎⁎⁎

Subsample 3
CSI → Fuel oil: spo1, t 0.770 0.384 0.996 2.391 −0.309 17.431⁎⁎⁎
(17.750)⁎⁎⁎
Fuel oil → CSI: spo2, t 0.013 −0.002 0.033 0.139 −0.008
(9.293)⁎⁎⁎

Notes: This table reports the descriptive statistics of estimated series of time-varying spillover effects, that is, spoi, t (i = 1,2) in Eq. (9). spo1, t refers to the effect from CSI 300 to fuel oil
futures markets while spo2, t refers to the effect from fuel oil to CSI 300 futures markets. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to
March 23, 2016; Subsample 3 is from March 24, 2016 to March 30, 2018. t-ratio denotes the t-test statistic for the null hypothesis that means of spoi, t (i = 1, 2) are equal to each
other. Std. Dev, standard deviation; Max, maximum; Min, minimum. Figures in the parenthesis are t-test statistics for the null hypothesis that mean of spoi, t (i = 1,2) is zero. ***, **,
and * denote significance at the 1%, 5% and 10% levels, respectively.

multivariate SNP distributional setting for those series. The advantage is
evidenced even though some estimates of skewness and kurtosis are
not significant.
Moreover, we estimate the revised DCC-GARCH-SNP models with
static volatility spillover which employ full sample of data. At the
same time, the subsampling dummies indicative of structural breaks
are included in the model to capture the effect of breaks on conditional
variances or the static spillover only taking place in Subsample 2 or 3.
These are examined due to the shortened sample path of Subsamples
2 and 3 resulting from sample splitting.16 The estimation result of
those models shows that estimates of marginal kurtosis, that is, k1 and
k2, are significant at the 1% level while those of marginal skewness, s1
and s2, are not significant.17 The result suggests that the advantage of
SNP approach is evident in the context of full sample with break
dummies and static interdependence between volatilities.
Finally, Panel D of the table shows that there is no heteroscedasticity
remaining in the standardized innovations, suggesting the entire model
is well specified.
4.3.2. Time-varying spillover
The estimation result of the DCC-GARCH-SNP model with time-
varying volatility spillover defined by the Legendre polynomials as in
Eq. (9) is reported in Table 7. In particular, the time-varying spillover ef-
fects, spoi, t(i = 1, 2) in Eq. (9), are controlled by the parameter δi, k (i =
1,2 and k = 0,1,2, 3, 4). In this subsection, we focus on estimates of δi, k
and resulting time variant dynamics of volatility spillover.
As can be seen from Panel A of the table, first, the conditional
heteroscedasticity is well captured for all subsamples given that the
conditional variances are conditioned on both past shocks and own
lagged values.18 In Panel A of the table, the sum of θ1i and θ2i (i = 1,
2) is smaller than one for all subsamples. The calculated long run aver-
age variances and stationarity of conditional variance series for all sub-
samples are discussed later.
Consistent with Table 6, for all subsamples, correlation between the
two markets is affected by past shocks and own values, as shown in
Panel B. Panel B shows that the sum of λ1 and λ2 is slightly larger than
one in Subsample 2. This raises a concern whether the estimated Qt in
Eq. (10) is positive definite. To check this, we calculate all eigenvalues
16
See details in Section 4.4.
17
Estimates of marginal skewness and kurtosis parameters are available upon request.
18
In Subsample 2 the conditional variance of fuel oil returns is only affected by persis-
tence of old news.
of Qt in the context of time varying volatility spillover for Subsample 2.
The result shows that all eigenvalues have positive minimum values
so that positive definiteness of Qt is ensured. The estimation on λ1 and
λ2 is accurate.
Similar to Table 6, Panel C shows that the SNP distribution signifi-
cantly captures marginal excess kurtosis of return distribution in Sub-
samples 1 and 3. However, marginal skewness might not be a
significant contributor to non-normality. Significant marginal kurtosis
parameters at the conventional significance levels in Subsamples 1
and 3 provide evidence for the salient advantage of the SNP distribution
where marginal kurtosis of multivariate time series can be captured.
Such advantage is supported by the result of the model considering
time varying volatility spillover, even though some skewness and kurto-
sis parameters are not significant. Analogous to the discussion in
Section 4.3.1, we estimate the revised DCC-GARCH-SNP models with
time varying volatility spillover employing full sample of data and the
subsampling dummies. The dummy variables are used to capture the ef-
fect of breaks on conditional variances or the time varying spillover only
taking place in Subsample 2 or 3.19 The estimation result shows that for
all models, estimates of marginal kurtosis, that is, k1 and k2, are signifi-
cant at the 1% level while those of marginal skewness, s1 and s2, are
not significant.20 The result confirms the advantage of the SNP approach
in the context of full sample with break dummies and time variant in-
terdependence between volatilities.
The residual diagnosis in Panel D suggests that the whole model sys-
tem is well specified as no heteroscedasticity is identified in the stan-
dardized residuals by the Ljung-Box test and ARCH test.
More importantly, in Panel A of Table 7, estimates of δi, k for all the i
and k are significant at the 1% level, across the three subsamples. This in-
dicates a significant time-varying feature of volatility spillover between
the fuel oil and CSI 300 futures markets. Since the sign and size of esti-
mated δi, k vary across conditional variance equations and subsamples,
we pay close attention to the estimated series of time-varying spillover
effects, that is, spoi, t(i = 1, 2), which is governed by δi, k. The descriptive
statistics of the series is shown in Table 8.
It is clear from the table that there are bilateral spillovers of volatility
between the two markets in all subsamples. This is indicated by the sig-
nificant means of spillover effects from fuel oil to CSI 300 and the other
way around for each subsample. In particular, for each subsample, the ef-
fect from CSI 300 to fuel oil is stronger than the other way around given
19
See details in Section 4.4.
20
Estimates of marginal skewness and kurtosis parameters are available upon request.
 Y. Hou et al. / Energy Economics 83 (2019) 119–143
higher mean of the former. Such difference is significant provided that the
null hypothesis of equal means is rejected at the 1% level, which is evi-
denced for all subsamples. In addition, all the means are positive, suggest-
ing lagged shocks of one market escalate volatility of the other. Therefore,
there are two-way dynamic volatility spillover between the fuel oil and
CSI 300 future markets whereby the latter market leads the former in
the transmission process. The result of time-varying spillover is consistent
with the long-run mean spillover revealed in Table 5. Moreover, standard
deviation of spillover effect from CSI 300 to fuel oil is higher than the other
way around across the three subsamples. Variation of spillover from CSI
300 to fuel oil is more unstable than that of the other way around.
The time varying long run average variances are calculated for the
three subsamples based on ML estimates of the individual GARCH
model that accounts for the time varying volatility spillover in the
DCC-GARCH-SNP model system. The descriptive statistics of the vari-
ances are shown in Panel A of Table A1 in Appendix A, in which we
use Eqs. (7) and (8) to calculate the variance series.
As can be seen from the table, for all three subsamples, the series of
long run average variances of both fuel oil and CSI 300 index futures mar-
kets are all positive across time.21 Moreover, Panel C of Table A1 shows
that estimated conditional variances of the fuel oil and CSI 300 index fu-
tures returns are stationary for the three subsamples, which is suggested
by Kwiatkowski-Phillips-Schmidt-Shin (KPSS) and Elliott-Rothenberg-
Stock (ERS) tests. Overall, the results suggest that the individual GARCH
model that captures the time varying volatility spillover governed by
the Legendre polynomials secures the positive long run average variance
through time, yielding stationary conditional variance series.
Panel B of Table A1 in the Appendix shows that for the three subsam-
ples, all the estimated conditional variances of the fuel oil and CSI 300
index futures markets are positive. This suggests that the estimation
process on the individual GARCH model that accounts for time varying
volatility spillover secures the positivity of conditional variance. Hence
our proposed methods to select appropriate starting values and other
relevant settings for MLE procedure are effective.
The likelihood ratio (LR) test is employed to test the null hypothesis
that the time-invariant model is valid, which is equivalent to setting the
restriction δi, 1 = … = δi, 4 = 0 (i = 1,2) in Eq. (9) for the DCC-GARCH-
SNP model. The test statistic is calculated as
LR ¼ 2½LnðTVC Þ−LnðFC
where LR denotes the log likelihood ratio test statistic. Ln is the log likeli-
hood. TVC denotes the model with time-varying volatility spillover while
FC denotes the model with time-invariant spillover. Note that the restric-
tion is put on the latter model. The test statistic is respectively calculated
for the subsamples. Result is shown in Panel E of Table 7. The test statistic
is significant at the 5% level for all the subsamples and the null is rejected.
Thus the model specification of time-varying spillover is justified.
In sum, dynamic volatility spillover confirms that the stock index fu-
tures market in China is information transmitter while the fuel oil fu-
tures market is information receiver. These roles in the information
transmission are not affected by the stock market crash in 2015. It is im-
plied that pricing dynamics of fuel oil futures depend on performance of
the Chinese stock index futures. It should be noted that the underlying
stock index is comprised of the constituent stocks a substantive propor-
tion of which is either fuel oil producers or consumers in China. It is their
21
We also compute the static long run average variances of the fuel oil and CSI 300 index
futures returns for the individual GARCH model that estimates the static volatility spill-
over. This model is based on Eqs. (6) and (9) where K is 0. The estimation results in Table 6
together with Eqs. (7) and (8) where spoi, t is replaced by spoi (i = 1,2) are used for calcu-
lation. The calculated static long run variances are positive for all three subsamples. For ex-
ample, variances of the fuel oil futures market are 0.1249, 1.76 × 10−3, and 5.51 × 10−3 for
subsamples 1, 2 and 3, respectively. Long run average variances of the CSI 300 index fu-
tures market are 2.51 × 10−3, 0.0206, and 0.1675 for subsamples 1, 2 and 3, respectively.
The results suggest that the individual GARCH model accounting for static volatility spill-
over possesses positive long run average variance and thus is justified.
133
stock performance that determines prices of fuel oil which is an input
for economic activities and such impact is not static. The effect is weaker
for the other way round. The Chinese stock market can function as a ba-
rometer for performance of the local fuel oil market. Our findings are
consistent with Li et al. (2017) who find the energy stock index in
China dominates the volatility spillover process with the fuel oil spot
and futures markets. Moreover, our result is similar to Mensi et al.
(2013) who suggest the S&P 500 index plays a leading role in the infor-
mation transmission process with the international oil markets. In addi-
tion, the evidence implies that the fuel oil has inferior power to affect
the volatility dynamics of the stock market. This is in alignment with
Chen et al. (1986), Huang et al. (1996), Lee et al. (2012) and Chang
et al. (2013) regarding the role of the global crude oil markets in the in-
formation transmission process with stock markets.
Fig. 2 depicts movements of conditional variances of the fuel oil and
CSI 300 futures returns with time-varying spillover effects taken into ac-
count. It is obvious that conditional variances exhibit distinct moving
patterns across the subsamples. Those patterns associate with differing
levels of GARCH effects reported in Table 7. Range of variation is widest
for the conditional variance of fuel oil futures returns in Subsample 3
while the other subsamples possess similar narrower ranges. This sug-
gests a heightened volatility of variance movement in the fuel oil market
after the structural break point. In a similar vein, we observe an elevated
volatility of conditional variance in the CSI 300 futures market during
the period around the market crash.
Dynamics of conditional correlation between the fuel oil and CSI 300
futures markets are shown in Fig. 3. The movements of correlations ex-
hibit strong autoregressive property across the subsamples, being con-
sistent with model estimates in Table 7. In addition, most of variations
stay above zero for Subsamples 1 and 2, suggesting a positive correla-
tion between the two markets over time. The variations mostly drop
below zero in Subsample 3 after the structural break in the fuel oil mar-
ket. During that period, CSI 300 futures returns move in opposite direc-
tions with fuel oil ones. One more observation is that value ranges of all
the subsamples are large, suggesting stability of correlations is not high.
Smooth motions of volatility spillover effects can be visualized in Fig. 4
for the subsamples. Consistent with Table 8, the stability of spillover effect
from CSI 300 to fuel oil is lower than the other way around. This can be
seen from a wider value range of variations in the former than in the latter
across the subsamples. The spillover from CSI 300 to fuel oil experience
more spikes and troughs. In addition, moving patterns of effects vary
across the subsamples. Fig. 4 supports the use of the Legendre function
to gauge the time-varying dynamics of volatility spillover.
What drives the increase or decrease of time varying volatility spill-
over depicted in Fig. 4 can be explained as follows. Volatility spillover re-
flects the quality of information contents of prices (Engle et al., 1990;
Chan et al., 1991; Chan, 1992; Yang et al., 2012). The literature has con-
cluded the evidence that information contents of cointegrated asset
prices can evolve over time (see, e.g. Ates and Wang, 2005; Chen and
Gau, 2010; Avino et al., 2015). Hence, volatility spillover effect of one
market is expected to change across time, positively corresponding
with varying information contents of that market.
One of the most important factors determining information contents
of financial markets is the activities of informed traders (Admati and
Pfleiderer, 1988; Back and Pederson, 1998; Fleming et al., 1996).
When more informed trading takes place in one market in a
cointegrated system, that market would contain superior information
contents and its spillover power would be stronger. For the fuel oil
and CSI 300 index futures markets, the activities of informed traders
to switch between the two markets might lead to the varying informa-
tion contents of the markets. They prefer to trade in one market with
more favourable market conditions such as trading costs, easiness to ac-
cess the market, extent of financialization, regulatory constraints and
other relevant factors (Fleming et al., 1996). Moreover, such behaviour
does not stay constant. Among these factors, we focus on the degree
of financialization of fuel oil market for explaining why volatility
134 Y. Hou et al. / Energy Economics 83 (2019) 119–143

Conditional variance, fuel oil, subsample 1 Conditional variance, CSI 300, subsample 1
.0024 .0010

.0020
.0008

.0016
.0006

.0012

.0004
.0008

.0002
.0004

.0000 .0000
13/9/2010 6/6/2011 27/2/2012 19/11/2012 12/8/2013 5/5/2014 26/1/2015 13/9/2010 6/6/2011 27/2/2012 19/11/2012 12/8/2013 5/5/2014 26/1/2015

Conditional variance, fuel oil, subsample 2 Conditional variance, CSI 300, subsample 2
.0035 .005

.0030
.004
.0025

.0020 .003

.0015
.002

.0010
.001
.0005

.0000 .000
15/6/2015 10/8/2015 5/10/2015 30/11/2015 25/1/2016 21/3/2016 15/6/2015 10/8/2015 5/10/2015 30/11/2015 25/1/2016 21/3/2016

Conditional variance, fuel oil, subsample 3 Conditional variance, CSI 300, subsample 3
.012 .0009

.0008
.010
.0007

.008 .0006

.0005
.006
.0004

.004 .0003

.0002
.002
.0001

.000 .0000
4/4/2016 8/8/2016 12/12/2016 17/4/2017 21/8/2017 25/12/2017 4/4/2016 8/8/2016 12/12/2016 17/4/2017 21/8/2017 25/12/2017

Fig. 2. Conditional variances of the fuel oil and CSI 300 futures markets. Notes: Conditional variances are estimated by the DCC-GARCH-SNP model with time varying spillover defined in
Eq. (9). Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March 23, 2016; and Subsample 3 is from March 24, 2016 to March 30, 2018.

spillover between the fuel oil and CSI 300 markets increases or
decreases.
The degree of financialization of fuel oil market comprises a crit-
ical feature of the market and is deemed important by local investors.
If financialization of fuel oil market enhances, that is, speculative de-
mand increases, more or fewer informed traders might access the
fuel oil market. This will lead to an increase or decrease of volatility
spillover of that market. A similar argument holds for the CSI 300
market.
We assess how financialization relates to volatility spillover in the
three subsamples by applying multiple regression analysis.22 The result
implies that before the Chinese stock market crash, higher degree of
financialization of fuel oil market attracts more informed traders in the
counterpart CSI 300 market. Less informed trading takes place in the oil
market.23 A rise (drop) of volatility spillover of fuel oil is due to decreased
(increased) degree of financialization of oil market. Meanwhile, a rise
22
We regress time varying cointegrating coefficient against time varying spillover coef-
ficient controlling for the autoregressive process of spillover. We use cointegrating coeffi-
cient as a proxy for degree of financialization following the discussion in Section 4.2.
23
Detailed results are available upon request.
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 135

Conditional correlation, subsample1

.6

.4

.2

.0

-.2

-.4

-.6
13/9/2010 6/6/2011 27/2/2012 19/11/2012 12/8/2013 5/5/2014 26/1/2015

Conditional correlation, subsample 2

1.0

0.8

0.6

0.4

0.2

0.0

-0.2

-0.4
15/6/2015 10/8/2015 5/10/2015 30/11/2015 25/1/2016 21/3/2016

Conditional correlation, subsample 3

1.00

0.75

0.50

0.25

0.00

-0.25

-0.50

-0.75

-1.00
11/7/2016 28/11/2016 17/4/2017 4/9/2017 22/1/2018

Fig. 3. Conditional correlations of the fuel oil and CSI 300 futures markets. Notes: Conditional correlations are estimated with the DCC-GARCH-SNP model with time varying
spillover defined in Eq. (9). Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March 23, 2016; and Subsample 3 is from March 24, 2016 to
March 30, 2018.
136 Y. Hou et al. / Energy Economics 83 (2019) 119–143

CSI --> Fuel oil, subsample 1 Fuel oil --> CSI, subsample 1

.12

.08
.10

.06 .08

.04 .06

.04
.02
.02
.00
.00

-.02
-.02
2/28/11 2/13/12 1/28/13 1/13/14 12/29/14 2/28/11 2/13/12 1/28/13 1/13/14 12/29/14

CSI --> Fuel oil, subsample 2 Fuel oil --> CSI, subsample 2

.7 .25

.6 .20

.5 .15

.4 .10

.3 .05

.2 .00

.1 -.05

.0 -.10

-.1 -.15
7/27/15 10/5/15 12/14/15 2/22/16 7/27/15 10/5/15 12/14/15 2/22/16

CSI --> Fuel oil, subsample 3 Fuel oil --> CSI, subsample 3

2.5 .16

2.0
.12

1.5
.08

1.0

.04
0.5

.00
0.0

-0.5 -.04
7/11/16 11/28/16 4/17/17 9/4/17 1/22/18 7/11/16 11/28/16 4/17/17 9/4/17 1/22/18

Fig. 4. The time-varying volatility spillover. Notes: “CSI → Fuel oil” stands for the volatility spillover from CSI 300 to fuel oil futures; “Fuel oil → CSI” stands for the volatility spillover from
fuel oil to CSI 300 futures. 95% confidence interval bands of the spillover are also depicted. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March
23, 2016; and Subsample 3 is from March 24, 2016 to March 30, 2018.

(drop) of volatility spillover of CSI 300 is due to increased (decreased) de-
gree of financialization of oil market.
In the aftermath of stock market crisis, we find more informed
traders enter the oil market when its financialization enhances. Given
such, their activities in the stock index futures market become relatively
fewer. Thus, higher spillover power of fuel oil and lower spillover power of
CSI 300 are observed. When financialization behaves otherwise, lower spill-
over power of fuel oil and higher spillover power of CSI 300 are observed.
This is because a proportion of informed traders are likely to move from
the former to the latter. We could conclude that a rise (drop) of volatility
spillover of fuel oil is due to increased (decreased) degree of financialization
of oil market. Meanwhile, a rise (drop) of volatility spillover of CSI 300 is due
to decreased (increased) degree of financialization of oil market.
Furthermore, it is observed that the patterns of volatility spillovers of
the two markets exhibit opposite moving directions. This phenomenon
is evident for all the subsamples. The reason is that the two markets
share the same information set that drives common efficient prices
due to cointegration. Higher (lower) volatility spillover of one market,
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 137

resulting from superior (inferior) information contents, should co-exist attention to how time varying spillover differs from static one. To this
with lower (higher) volatility spillover of the other market, resulting end, we calculate the optimal asset allocation of a buy-and-hold portfo-
from inferior (superior) information contents. lio containing the two futures assets without short-selling. The optimal
weights of two assets will be determined by minimising the variance of
4.3.3. Implications for forecasting portfolio returns without reducing expected returns.
We can forecast the conditional variance of the fuel oil futures mar- Suppose a buy-and-hold portfolio worth one dollar is formed by tak-
ket by means of the DCC-GARCH-SNP models accounting for static and ing long positions in two assets, fuel oil and CSI 300 index futures con-
time varying volatility spillovers. Here we compare the forecasting per- tracts. Following Kroner and Ng (1998), the optimal weight for the
formance between static and time varying spillover models to assess the first asset, fuel oil futures, is determined by
superiority of the latter. 8
To this end, we employ three metrics to measure the forecasting h22;t −h12;t < 0; w1 b0
ability: Mean Absolute Error (MAE), Mean Squared Error (MSE) and w1 ¼ ; with w1 ¼ w1 ; 0bw1 b1 ð22Þ
h11;t −2h12;t þ h22;t :
Root Mean Squared Error (RMSE) which are defined as 1; w1 N1

PT ^
PT 
^t
2
where w1 is the dynamic optimal weight of fuel oil at time t. h11, t and h22, t
t¼1 ht −ht t¼1 ht −h
MAE ¼ ; MSE ¼ ; ð21Þ are the conditional variances of fuel oil and CSI 300, respectively. h12, t is
T T the conditional covariance of these two assets. The optimal weight of CSI
vffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi
uP  2 300, w2, is therefore (1 − w1). Note that w1 and w2 are both time variant.
u T ^t
t t¼1 ht −h As for the implication for risk management, we consider the mini-
RMSE ¼ :
T mum variance cross-hedging strategy to hedge against price move-
ments of a fuel oil futures asset by using the CSI 300 futures contracts.
where ht denotes the sample variance of fuel oil at time t that is calcu- A hedged portfolio is constructed with a long position in one unit of
lated by a rolling window method; h ^ t denotes the forecasted conditional the fuel oil contracts and a short position in h units of the CSI 300 con-
variance at time t by the DCC-GARCH-SNP model. Note that the window tracts. Following Kroner and Sultan (1993) and Lien and Shrestha
size is 10 observations and step size is 1 observation in the rolling win- (2007), we compute the optimal h ∗ which minimises the variance of
dow procedure. For each subsample, we estimate the models using 60% hedged portfolio returns by the following equation:
of data observations. The remaining 40% of the sample are used to fore-
cast the conditional variance. The calculated forecasting performance  h12;t
h ¼ : ð23Þ
measures are reported in Table 9. h22;t
As shown by Table 9, all the three measures are small, suggesting the
strong forecasting power of pricing dynamics of the CSI 300 index futures where h12, t is the conditional covariance of the fuel oil and CSI 300 fu-
for the volatility of fuel oil market. This result aligns with the leading role tures returns. h22, t is the conditional variance of the CSI 300 futures.
of the former market in the information transmission process revealed in Note that h ∗ updates across time.
this study. Moreover, all the three measures generated by the time varying Means of dynamic optimal weights and hedge ratios are presented
model are lower than the static model. The result suggests that the time in Table 10. As can be seen from Panel A, optimal weights on fuel oil
varying model has higher forecasting capacity than the static counterpart. and CSI 300 index futures assets to achieve efficient diversification are
Therefore, one can see the superiority of the time varying spillover model, different between the DCC-GARCH-SNP models with static and time
which supports the time varying feature of volatility spillover. varying volatility spillovers. For Subsamples 1 and 3, a higher weight

4.3.4. Implications for portfolio risk management Table 10

In this subsection, we consider how the volatility spillover of futures Minimum variance portfolio weight and hedge ratio.
markets between fuel oil and stock index assets can assist investors in
Time varying Static
efficient portfolio diversification and risk management. We pay
Panel A: Minimum variance portfolio weight
Subsample 1
Table 9
w1 0.547 0.539
Forecasting performance on fuel oil volatility.
w2 0.453 0.461
Forecasting performance Subsample 2
w1 0.577 0.619
MAE MSE RMSE w2 0.423 0.381
Subsample 1 Subsample 3
Static 1.837 × 10−3 3.771 × 10−6 1.942 × 10−3 w1 0.225 0.212
Time varying 5.249 × 10−4 3.759 × 10−7 6.131 × 10−4 w2 0.775 0.788

Subsample 2 Panel B: Minimum variance hedge ratio

Static 3.798 × 10−4 2.905 × 10−7 5.389 × 10−4 Subsample 1
Time varying 2.846 × 10−4 1.640 × 10−7 4.050 × 10−4 h∗ 0.054 0.064
Subsample 2
Subsample 3 h∗ 0.177 0.187
Static 4.510 × 10−4 2.660 × 10−7 5.157 × 10−4 Subsample 3
Time varying 4.209 × 10−4 2.564 × 10−7 5.063 × 10−4 h ∗
−0.144 −0.161

Notes: This table reports the forecasting performance of the DCC-GARCH-SNP models ac-
counting for static and time varying volatility spillover on forecasting the conditional variance
of fuel oil futures returns. Forecasting is conducted for each subsample. 60% of observations
are used for obtaining model estimates and the other 40% are used to forecast conditional
variance. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May
27, 2015 to March 23, 2016; Subsample 3 is from March 24, 2016 to March 30, 2018. Static,
the DCC-GARCH-SNP model with static spillover; Time varying, the DCC-GARCH-SNP model
with time varying spillover. MAE, mean absolute error; MSE, mean squared error; RMSE, root
mean squared error. Rolling window method is used to calculate sample variance series
which are compared with forecasted ones for calculation of performance measures.
Notes: This table reports the means of optimal weights of fuel oil and CSI 300 index futures
which are used to construct a minimum variance portfolio. It also reports the means of opti-
mal hedge ratios of minimum variance cross-hedging strategy involving fuel oil and CSI 300
futures contracts. Optimal weights and hedge ratios are obtained from Eq. (22) and (23), re-
spectively. Static denotes that the results are derived from the DCC-GARCH-SNP model with
static volatility spillover; Time varying denotes that the results are obtained via the DCC-
GARCH-SNP model with time varying volatility spillover. w1 is the mean of optimal weight
of fuel oil; w2 is the mean of optimal weight of CSI 300. h ∗ is mean of the optimal hedge
ratio. Subsample 1 is from May 17, 2010 to May 26, 2015; Subsample 2 is from May 27,
2015 to March 23, 2016; Subsample 3 is from March 24, 2016 to March 30, 2018.
138 Y. Hou et al. / Energy Economics 83 (2019) 119–143
is invested in fuel oil futures asset to achieve minimized portfolio risk, as
suggested by the time varying spillover model. The result is reversed for
Subsample 2 where the time varying model suggests a lower weight on
fuel oil. Another obvious observation is that before the break event,
minimum variance portfolio strategy requires a larger weight on the
fuel oil futures asset. In contrast, after the event, a larger weight is sug-
gested for the stock index futures asset. This result is consistent be-
tween the time varying and static spillover models. It aligns with the
notion for establishing a risk-efficient portfolio that investors prefer
investing their funds in a market with lower risk.
Panel B of the table shows that optimal hedge ratios estimated by the
time varying spillover model differ from those by the static one. Note that
for Subsamples 1 and 2 we take a short position in the CSI 300 futures to
construct a hedged portfolio while for Subsample 3 we take a long position
in the same asset to achieve the goal. Moreover, we find that we could buy
or sell fewer CSI 300 futures contracts to achieve minimum variance cross
hedging, as indicated by the time varying spillover model. It suggests that
accounting for the time varying volatility spillover helps to achieve a more
cost-effective hedging strategy than the static counterpart. This supports
the superiority of the model involving the time varying spillover effect.
4.4. Robustness check
Note that the length of Subsample 2 is relatively small. The estimation
result for this subsample might be questionable since smaller sample size
might undermine the accuracy of result. There is a need to examine
whether subsampling of the whole sample to take account of structural
breaks is appropriate. To this end, we define two dummy variables, d1, t
and d2, t, to be indicative of two subsamples. d1, t equals to 1 when the
time is from May 17, 2010 to May 26, 2015, that is, Subsample 1, and
zero otherwise. d2, t is unity when the time is from May 27, 2015 to
March 23, 2016, that is, Subsample 2, and zero otherwise. Then we modify
the conditional variance equation of Eq. (6) to incorporate the effects of
structure breaking dummies, d1, t and d2, t, on conditional volatilities. In
addition, we specifically estimate the time varying volatility spillover of
Subsample 2 solely in the context of the full sample of data by an alterna-
tive modified conditional variance equation based on Eq. (6). In such set-
ting, only d2, t is used in the model. The full sample is used to estimate the
DCC-GARCH-SNP model with the modified individual conditional vari-
ance equations in order to alleviate the problem of shortened sample
path due to sample splitting.24 The two-step estimation procedure de-
scribed in Section 3 applies for the estimation.
Also, we utilize the above two revised conditional variance equations
to estimate the static volatility spillover. Similar to the time varying coun-
terpart, the full sample is utilized for estimation. The results of the two
modified models that account for static or time varying volatility spillover
are presented in Table A2 in Appendix B. We mainly report results of time
varying spillover since it is the focus of this paper.25
As can be seen from Panel D of Table A2, both models are well specified
as suggested by residual diagnosis. Overall, the estimation results in Panels A,
B and C of Table A2 are similar to Table 7. When full sample is used for esti-
mation, time varying volatility spillover is significantly controlled by the Le-
gendre polynomials. Hence, time variation of volatility spillover is found in
the context of the whole sample path and structural break dummies.
Panel F shows result of the static volatility spillover. It is found that
there is no spillover between the two markets. However, Panel E
shows results similar to Table 8 where there is bilateral spillover be-
tween the two markets. Further, the strength of spillover from CSI 300
24
Please see the details of modified conditional variance equations in the notes of
Table A2 in Appendix 2.
25
Note that the subsample dummies d1, t and d2, t are also taken into account for the
static and time varying cointegration tests and estimation of the VECM. Full sample is
employed for these tests. The results show that cointegration does not exist assuming
the cointegrating coefficient is static; however, it does exist when the coefficient is time
varying. Hence the cointegrating relation is time varying. The results (available upon re-
quest) of VECM are similar to those for the three subsamples.
market to the fuel oil one is significantly higher than the other way
around. Hence, accounting for time variation of volatility spillover re-
veals new evidence comparing to the static counterpart. This is similar
to what is suggested by the results under the subsampling context.
The results for time varying volatility spillover are rarely impacted by
the problem of shortened sample size of Subsample 2.26
5. Concluding remarks
In this paper, we study the time-varying volatility spillover between
fuel oil and stock index futures markets in China based on the data set of
daily prices from May 17, 2010 to March 30, 2018. The full sample is
split into three subsamples due to two structural breaks. We employ
the SNP approach to addresses the marginal third and fourth moments
of the multivariate return distribution.
The time-varying cointegration test of Park and Hahn (1999) is
employed to test the existence of cointegration between fuel oil and CSI
300 futures prices for each subsample. We find that cointegration exists
only in the situation that cointegrating coefficient is time-variant. The
time-varying feature of dynamic cointegrating relationship is confirmed
by an empirical test. Therefore, a bivariate VECM accounting for the dy-
namic cointegration is employed to specify the conditional mean of
returns. A bivariate DCC-GARCH model is used to estimate the conditional
variance-covariance matrix where the time-varying between-market vol-
atility spillover is modelled by the Legendre polynomials. Time-invariant
spillover is also estimated for comparison purpose. The SNP distribution
that accounts for both marginal skewness and kurtosis of return distribu-
tion is used for the estimation of the DCC GARCH model.
Overall, accounting for the time-varying feature of the volatility spillover
yields some significant new evidence. The time-invariant spillover model
suggests that the spillover between the fuel oil and CSI 300 markets is a
one-way interaction with the direction varying across the subsamples and
that the spillover effects suggest that the recent information shocks from
one market decrease the volatility of the other. In contrast, the time-
varying spillover model finds that the spillover is significantly bilateral be-
tween the two markets for all the subsamples and that the spillover effects
suggest that the recent shocks from one market increase the volatility of the
other on average. Furthermore, inconsistency is found between results of
time-invariant volatility spillover and long-run mean spillover with the lat-
ter indicating that the CSI 300 futures market leads the fuel oil counterpart
in the long run. The time varying spillover model suggests that the effect
from CSI 300 to fuel oil markets is significantly stronger than the other
way around for all the subsamples, implying a leading role of the stock
index futures market in the information transmission. This role is not af-
fected by the Chinese stock market crash in 2015.
This paper contributes to the literature in the following aspects. First, in
contrast to the previous studies most of which only focus on static pricing re-
lationships between oil and equity markets, this study reveals new evidence
that a long-run equilibrium that varies across time exists between the fuel oil
and stock index futures markets in China. Second, this paper unveils that
time-varying volatility spillover is significant between the fuel oil and stock
index futures markets in China. Accounting for the time-varying feature of
volatility spillover yields more insights on market efficiency. Third, this
paper validates the use of the SNP approach for capturing the non-
normality feature of return distribution for equity-oil pricing relationship.
Our findings have important implications for stakeholders in the fuel
oil market including fuel oil sellers, producers or consumers. In China, the
stock market has the capability to affect pricing dynamics of fuel oil, but
26
We also check whether the results of time varying volatility spillover from Subsample 3
are different from those estimated by the full sample. We define a dummy, that is, d3, t, for
Subsample 3 that takes a value of 1 if the time falls within that subsample and zero otherwise.
We estimate the static and time varying volatility spillovers only for the period of Subsample
3 by using the full sample for the estimation. The process above is repeated where the con-
ditional variance equation is modified to achieve the purpose. The results (available upon re-
quest) from the full sample are similar to those in Tables 7 and 8. It confirms the robustness of
the result of time varying volatility spillover regarding the sample splitting problem.
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 139

not vice versa. Thus, performance of the former can explain a significant
proportion of the market movements of the latter, and the former has a
strong forecasting power for the latter's risk level. For either fuel oil sup-
pliers or consumers that are publicly listed, their stock performance has
an impact on fuel oil price and such impact evolves over time. Moreover,
for portfolio diversification and risk management, the strong dynamic
linkages between fuel oil and CSI 300 futures contracts are helpful for es-
tablishing a well-diversified portfolio. This is especially the case in the re-
cent period during which correlations are substantially negative. Further,
the variance-covariance matrix accounting for the time-varying spillover
effects may facilitate the more effective minimum-variance hedge.

Appendix A. Descriptive statistics of the long run average and conditional variances and results of stationarity tests

Table A1
Descriptive statistics of the long run average and conditional variances and results of stationarity tests.

Mean STD Max Min

Panel A: Descriptive statistics of the long run average variances

Subsample 1
VL, 1 0.0078 0.0214 0.6902 0.0024
0.0004 0.0023 0.0748 2.17 × 10−5
VL, 2 0.0049 0.0128 0.4113 0.0012
0.0002 0.0008 0.0242 6.66 × 10−5
Subsample 2
VL, 1 0.0013 0.0009 0.0102 2.40 × 10−5
0.0013 0.0084 0.1190 7.54 × 10−5
VL, 2 0.0078 0.0237 0.3339 0.0010
0.0010 0.0029 0.0403 6.84 × 10−5
Subsample 3
VL, 1 0.0067 0.0082 0.1423 0.0044
0.0016 0.0054 0.0885 0.0003
VL, 2 0.0002 0.0003 0.0050 0.0001
0.0001 0.0002 0.0035 6.38 × 10−5

Panel B: Descriptive statistics of conditional variances

Mean STD Max Min
Subsample 1
h11, t 0.0003 0.0003 0.0021 9.55 × 10−7
h22, t 0.0002 0.0001 0.0010 5.36 × 10−5
Subsample 2
h11, t 0.0006 0.0005 0.0032 0.0001
h22, t 0.0008 0.0006 0.0041 3.05 × 10−7
Subsample 3
h11, t 0.0007 0.0011 0.0111 1.74 × 10−6
h22, t 8.70 × 10−5 8.08 × 10−5 0.0008 7.65 × 10−7

Test statistics KPSS ERS

Subsample 1
h11, t 0.3454 6.5226⁎⁎
h22, t 0.2154 10.4525⁎⁎

Subsample 2
h11, t 0.3268 32.9960⁎⁎
h22, t 0.2740 56.6622⁎⁎

Subsample 3
h11, t 0.0849 29.0749⁎⁎
h22, t 0.3449 77.0117⁎⁎

Notes: This table reports descriptive statistics of estimated long run average variances and conditional variances based on the individual GARCH models with time varying volatility spillover in the DCC-
GARCH-SNP model system. Results of stationarity tests on conditional variances are also reported. VL, 1 and VL, 2 are the long run average variances of the fuel oil and CSI 300 index futures returns, re-
θ0i 1−θ1 j −θ2 j θ0 j 1−θ1 j −θ2 j θ0 j
spectively. The first row of VL, 1 and VL, 2 is calculated by the equation V L;i ¼ −spoi;t ; the second row is calculated by the equation V L;i ¼ θ0i þ spoi;t . h11, t and
1−θ1i −θ2i d d d d
h22, t are the conditional variances of the fuel oil and CSI 300 index futures, respectively. KPSS denotes the Kwiatkowski-Phillips-Schmidt-Shin test. The null of the test is that time series is stationary. The
asymptotic critical value at the 5% level is 0.4630. ERS denotes the Elliott-Rothenberg-Stock test with the null that time series has a unit root. Critical value at the 5% level is 3.2600. Subsample 1 is from May
17, 2010 to May 26, 2015; Subsample 2 is from May 27, 2015 to March 23, 2016; and Subsample 3 is from March 24, 2016 to March 30, 2018. STD denotes standard deviation; Max denotes maximum
value; Min denotes minimum value. ** denotes significance at the 5% level.

Appendix B. Volatility spillover in the DCC-GARCH-SNP model with subsampling dummies

Table A2
Static and time varying volatility spillover in the DCC-GARCH-SNP model with subsampling dummies.

Coefs. The DCC-GARCH-SNP, controlling for two The DCC-GARCH-SNP, controlling for the dummy
subsample dummies of Subsample 2

i=1 i=2 i=1 i=2

Panel A: Conditional variance

θ0i 1.97 × 10–5⁎⁎⁎ 2.74 × 10–6⁎⁎⁎ 2.17 × 10–7⁎⁎⁎ 9.22 × 10–7⁎⁎⁎
(8.10 × 10−7) (5.07 × 10−7) (3.98 × 10−8) (2.57 × 10−7)

(continued on next page)

140 Y. Hou et al. / Energy Economics 83 (2019) 119–143

Table A2 (continued)

Coefs. The DCC-GARCH-SNP, controlling for two The DCC-GARCH-SNP, controlling for the dummy
subsample dummies of Subsample 2

i=1 i=2 i=1 i=2

θ1i 0.053⁎⁎⁎ 0.054⁎⁎⁎ 0.021⁎⁎⁎ 0.045⁎⁎⁎

(0.0029) (0.0049) (0.0008) (0.0039)
θ2i 0.924⁎⁎⁎ 0.915⁎⁎⁎ 0.979⁎⁎⁎ 0.952⁎⁎⁎
(0.0025) (0.0072) (0.0004) (0.0044)
δi, 0 0.054 0.559⁎⁎⁎ −7.141 57.938⁎⁎⁎
(0.0645) (0.1839) (37.7372) (0.1258)
δi, 1 −0.008 −1.236⁎⁎⁎ −9.239 −40.267⁎⁎⁎
(0.1454) (0.4119) (66.7332) (0.3780)
δi, 2 −0.120 1.086⁎⁎⁎ 55.638⁎⁎ −122.496⁎⁎⁎
(0.1370) (0.3724) (27.4612) (0.9389)
δi, 3 0.227⁎⁎⁎ −0.527⁎⁎⁎ −58.370⁎⁎⁎ 162.548⁎⁎⁎
(0.0746) (0.1890) (7.6910) (0.8097)
δi, 4 −0.235⁎⁎⁎ 0.115⁎⁎ 25.978⁎⁎⁎ −73.589⁎⁎⁎
(0.0222) (0.0452) (9.7154) (0.3873)
η1i −1.65 × 10–5⁎⁎⁎ 2.42 × 10–6⁎⁎⁎
(7.69 × 10−7) (6.26 × 10−7)
η2i −3.21 × 10–5⁎⁎⁎ 1.38 × 10–5⁎⁎⁎
(3.05 × 10−6) (4.04 × 10−6)

Panel B: Conditional correlation

λ1 0.111⁎⁎⁎ 0.040⁎⁎⁎
(0.0077) (0.0080)
λ2 0.860⁎⁎⁎ 0.791⁎⁎⁎
(0.0130) (0.0697)

Panel C: SNP distribution

s1 0.083 −0.054
(0.1348) (0.1387)
s2 0.131 0.149471
(0.1977) (0.222183)
k1 3.959⁎⁎⁎ 3.901⁎⁎⁎
(0.9399) (0.9611)
k2 6.643⁎⁎⁎ 6.855⁎⁎⁎
(2.3018) (2.5433)

Panel D: Residual diagnosis

Log L 15,737.324 15,624.429
LB2(Arouri et al., 2012) 2.003 4.501 4.681 7.366
ARCH (Arouri et al., 2012) 1.957 4.601 4.495 7.535

Panel E: Descriptive statistics of time varying volatility spillover

CSI 300 → Fuel oil
Mean 0.021 0.005
(27.472)⁎⁎⁎ (6.646)⁎⁎⁎
Std. Dev. 0.035 0.0117
Fuel oil → CSI 300
Mean 0.007 0.003
(23.548)⁎⁎⁎ (2.508)⁎⁎
Std. Dev. 0.013 0.016
Mean equality test 17.754⁎⁎⁎ 1.833⁎

Panel F: Static volatility spillover

CSI 300 → Fuel oil −0.002 0.001
(0.0010) (0.0011)
Fuel oil → CSI 300 −7.53 × 10−5 −0.003
(0.0003) (0.0033)

Notes: This table reports the estimation results of two DCC-GARCH-SNP models capturing both time varying volatility spillover and the effects of structural breaks. Full sample is used for
model estimation. In particular, the models take into account the effects of dummies of subsamples on conditional variances of fuel oil and CSI 300 futures returns as well as volatility spill-
over between the two markets only associating with Subsample 2 when full sample is used. The DCC-GARCH-SNP, controlling for two subsample dummies denotes the model with condi-
tional variance equations including a dummy for Subsample 1, that is, d1, t, and a dummy for Subsample 2, that is, d2, t. Note that Subsample 1 is from May 17, 2010 to May 26, 2015
and Subsample 2 is from May 27, 2015 to March 23, 2016. d1, t takes a value of 1 when the time is from May 17, 2010 to May 26, and zero otherwise. d2, ttakes a value of 1 when the
time is from May 27, 2015 to March 23, 2016, and zero otherwise. The specification of conditional variance in the model is shown as hii, t = θ0i + η1id1, t + η2id2, t + θ1ie2i, t−1 + θ2ihii, t
2
−1 + spoi, tej, t−1 (i = 1,j = 2;i = 2,j = 1) where spoi, t captures the time varying volatility spillover defined by the Legendre polynomials as in Eq. (9). η1i and η2i capture the effects
of Subsample 1 and Subsample 2 on conditional variances, respectively. The DCC-GARCH-SNP, controlling for the dummy of Subsample 2 denotes the model with conditional variance equa-
tions including the interactive term spoi, td2, te2j, t−1 which illuminates the time variant volatility spillover in Subsample 2 when full sample is employed. The conditional variance equation is
written as hii, t = θ0i + + θ1ie2i, t−1 + θ2ihii, t−1 + spoi, td2, te2j, t−1 (i = 1,j = 2;i = 2,j = 1) where spoi, t is time varying volatility spillover for Subsample 2 only and defined as in Eq. (9).
Corresponding parameters δi, k (i = 1,2;k = 0,…,4) in Eq. (9) are estimated. Estimates of Eqs. (10), (12) and (13) are also reported. Coefs. denotes coefficients. i = 1 refers to the condi-
tional variance equation of fuel oil while i = 2 refers to the conditional variance equation of CSI 300. Log L, maximized log-likelihood of the model. LB2(Arouri et al., 2012) is the Ljung-Box Q
statistics of squared standardized residuals up to lag order 6. ARCH (Arouri et al., 2012) denotes the test statistic for testing the ARCH effect up to lag order 6. In Panel E, descriptive statistics
of estimated spoi, t from the two models are reported. “CSI 300 → Fuel oil” stands for spillover from CSI 300 market to fuel oil market; “Fuel oil → CSI 300” stands for spillover from fuel oil
market to CSI 300 market. Std. Dev., standard deviation. Mean equality test is the test with null hypothesis that means of time varying volatility spillover from CSI 300 market to fuel oil
market and the other way round are equal. t-test statistics are showed. In Panel F, the results of the two full-sample models with static volatility spillover and subsample dummies are
showed. The static spillover is captured by δi, k in Eq. (9) where the order K is 0. Note δi, 0 = spoi. Figures in the parentheses are standard errors. ***, **, and * denote significance at the
1%, 5% and 10% levels, respectively.
 Y. Hou et al. / Energy Economics 83 (2019) 119–143 141

Appendix C. Details of time varying cointegration test where RSSTVC and RSSsTVC are the sum of squared residuals from the CCR
for Eq. (A3.1) or (A3.5) and the same regression augmented with s ad-
Suppose Ot and Pt are the natural logarithms of daily prices of the fuel ditional superfluous regressors, respectively. ω ∗ 2 is the conditional
oil and China Securities Index (CSI) 300 index futures, respectively. If long-run variance of the regression errors under the null. If s is chosen
the two series are integrated at the same order, that is, they have the to be 4, the testing equation under the alternative hypothesis is
same number of unit roots, a cointegration relationship might exist Eq. (A3.1) or (A3.5) augmented by t, t2, t3 and t4 where t is the time
between them. If we assume the cointegrating coefficient is time trend. Such equation implies non-stationarity of innovations ut in
variant rather than static, a cointegrating equation can be repre- Eq. (A3.1) and misspecification of Eq. (A3.1) or (A3.5) under the null.
sented as Under the null hypothesis of a true time varying cointegration model,

 the limit distribution of τ ∗ is a chi-square distribution with s degree of
t freedom.
Ot ¼ β0 þ β P t þ ut : ðA3:1Þ
n On the other hand, the null hypothesis of the validity of the time-
t
where β0 is a constant mean of the equation and ut denotes innova- invariant coefficient cointegration model, that is, βð Þ in Eq. (A3.1) is
n
t static over time, can be tested by the statistic
tions of the equation or the well-known error correction term. βð
n
t RSSFC −RSSsFC
Þ is the time varying cointegrating coefficient which varies with ð Þ τ1 ¼ : ðA3:7Þ
n ω2
where t is the order of observation in the sample and n denotes the
t
sample size. We have βð Þ ≡ βðλÞ such that λ ∈ (0, 1]. Hence β(λ) is where RSSFC and RSSsFC are the sum of squared residuals from the CCR es-
n
a smooth function defined on [0,1]. timation of Eq.(A3.1) with the time-invariant cointegrating coefficient
According to Park and Hahn (1999), the time-series parameters, and the same regression augmented by s additional superfluous regres-
β(λ), can be approximated by the Fourier flexible form (FFF) functions, sors, respectively. ω ∗ 2 is the conditional long-run variance of the re-
gression errors under the null. If s is 4, the superfluous regressors are
X
k
t, t2, t3 and t4. The limit distribution of τ1∗ is the chi-square distribution
βk ðλÞ ¼ α k;1 þ α k;2 λ þ α k;2iþ1 ; α k;2ðiþ1Þ φi ðλÞ: ðA3:2Þ with s degree of freedom under the null.
i¼1

where αk, j ∈ R2for j = 1, 2, …, 2(k + 1) and k is some positive integer. φi Appendix D. The Legendre polynomials
(λ) =(cos2πiλ, sin2πiλ)′. Alternatively, Eq. (A3.2) can be shown as
In mathematics, Legendre functions are solutions to Legendre's dif-
βk ðλÞ ¼ α k;1 þ α k;2 λ þ α k;3 cos2πλ þ α k;4 sin2πλ þ α k;5 cos4πλ ferential equation:
þ α k;6 sin4πλ þ … þ α k;2kþ1 cos2πkλ

þ α k;2ðkþ1Þ sin2πkλ: ðA3:3Þ d
d
1−z2 Lk ðzÞÞ þ kðk þ 1ÞLk ðzÞ ¼ 0: ðA4:1Þ
dz dz
Thus, the time variation of β(λ) is gauged by trigonometric polyno-
mial functions with 2 k + 2 parameters. Moreover, k is small enough to Eq. (A4.1) may be solved using the standard power series method.
keep sufficient smoothness for β(λ). The Bayesian Information Criteria The equation has regular singular points at z = ± 1. The requirement,
(BIC) is used to choose appropriate k. −1 b z b + 1, enables the convergence of a series of solution about
Let fk(λ) = (1,λ, φ1′(λ),…, φk′(λ))′withλ ∈ (0, 1] and αk = (αk, 1, αk, the origin. As k is some positive integer, the solution Lk(z) is regular at
2,…,αk, 2(k+1))′. Then βk(λ) can be rewritten as z = 1 and z = −1. And the series for the solution stops. The solution
procedure implies Lk(z) is a polynomial. Detailed illustrations on the Le-
βk ðλÞ ¼ f k 0ðλÞα k ðA3:4Þ gendre polynomials can be seen in e.g. Arfken and Weber (2005) and
Bayin (2006).
Then Eq. (A3.1) can be alternatively shown as The solutions for k = 0, 1, 2, …, n form a polynomial sequence of or-
thogonal polynomials that are called Legendre polynomials. Each Le-
Ot ¼ β0 þ α0k P kt þ ukt : ðA3:5Þ
gendre polynomial of Lk(z) for a k is an kth-degree polynomial. It can
be presented as
where
Pkt = fk(λ)Pt, and ukt = ut + [β(λ) − βk(λ)]Pkt.
1 d 2
k
k
According to Park and Hahn (1999), as k increases with the sample Lk ðzÞ ¼ z −1 : ðA4:2Þ
k k
size n, a consistent estimate of Π(β) can be obtained. The conventional 2 k! dz
ordinary lease squares (OLS) is not appropriate to estimate Eq. (4) due
to the endogeneity problem of the error terms and non-Gaussian Alternatively, Eq. (A4.2) can be defined as the coefficients in a Taylor
(Park and Zhao, 2010). Park and Hahn (1999) propose the use of the ca- series expansion:
nonical cointegration regression (CCR) method (Park, 1992) which can
obtain an efficient estimator and a valid inferential basis for the coeffi- 1 X∞

cients. In particular, the CCR estimator of βk is a consistent estimator pffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffiffi ¼ Lk ðzÞt k : ðA4:3Þ
1−2zt þ t 2
k¼0
of β and its distribution is limited normal. βk can be recovered by
Eq. (A3.4) given the CCR estimator.
Park and Hahn (1999) employ the superfluous regressors approach If we expand the Taylor series in Eq. (A4.3) for the first two terms,
to test the null hypothesis of the time varying coefficient cointegration we can obtain
against the alternative of the spurious regression with non-stationary
innovations (Park and Zhao, 2010). The test statistic is L0 ðzÞ ¼ 1; L1 ðzÞ ¼ z ðA4:4Þ

RSSTVC −RSSsTVC Hence Eq. (A4.4) is the first two Legendre polynomials. We can ob-
τ ¼ : ðA3:6Þ
ω2 tain further expressions by differentiating Eq. (A4.3) in respect of t on
142 Y. Hou et al. / Energy Economics 83 (2019) 119–143

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Bollerslev, T., 1990. Modelling the coherence in short-run nominal exchange rates: a mul-
z−t
X∞
tivariate generalized ARCH model. Rev. Econ. Stat. 52, 5–59.
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Chen, N., Roll, R., Ross, S.A., 1986. Economic forces and the stock market. J. Bus. 59,
order of n can be represented as 383–403.
Chen, K.C., Chen, S.L., Wu, L.F., 2009. Price causal relations between China and the world
X
n


n n þ k−1 oil markets. Glob. Financ. J. 20, 107–118.
Ln ðzÞ ¼ 2n zk nÞ: ðA4:7Þ Chen, H.Q., Han, Q., Li, Y.X., Wu, K., 2013. Does index futures trading reduce volatility in
k 2
k¼0 the Chinese stock market? A panel data evaluation approach. J. Futur. Mark. 33
(12), 1167–1190.
Choi, K., Hammoudeh, S., 2010. Volatility behaviour of oil, industrial commodity and stock
In this study, we choose n to be 4. Henceforth, Eq. (A4.7) suggests the markets in a regime-switching environment. Energy Policy 38, 4388–4399.
first few Legendre polynomials are Cong, R.G., Wei, Y.M., Jiao, J.L., Fan, Y., 2008. Relationships between oil price shocks and
stock market: an empirical analysis from China. Energy Policy 36, 3544–3553.
L0 ðzÞ ¼ 1; Cramér, H., 1925. On some Classes of Series Used in Mathematical Statistics.
Skandinaviske Matematikercongres, Copenhagen.
Creti, A., Joëts, M., Mignon, V., 2013. On the links between stock and commodity markets'
L1 ðzÞ ¼ z; volatility. Energy Econ. 37, 16–28.
Cunado, J., de Gracia, F.P., 2014. Oil price shocks and stock market returns: evidence for

some European countries. Energy Econ. 42, 365–377.
L2 ðzÞ ¼ 0:5 3z2 −1 ;
Del Brio, E.B., Níguez, T.M., Perote, J., 2011. Multivariate semi-nonparametric distributions
with dynamic conditional correlations. Int. J. Forecast. 27, 347–364.

L3 ðzÞ ¼ 0:5 5z3 −3z ;
and
Du, L., He, Y., Wei, C., 2010. The relationship between oil price shocks and China's macro-
L4 ðzÞ ¼ 0:125 35z4 −30z2 þ 3 :
Appendix E. Supplementary data
Supplementary data to this article can be found online at https://doi.
org/10.1016/j.eneco.2019.06.020.
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