Dynamic Interaction of Coconut Oil and Crude Oil Prices: Insights from a Vector Error Correction Model

Abstract

Understanding the relationship between commodity prices is paramount for investors, policymakers, and industries reliant on these markets. This study delves into the intricate dynamics between coconut oil and crude oil prices using a Vector Error Correction Model (VECM). The VECM approach allows for exploring these commodities' short-term adjustments and long-term equilibrium relationships. The analysis reveals that while there may not be a strong long-term interdependence between coconut oil and crude oil prices, robust short-term adjustment mechanisms exist. The cointegration rank two (2) highlights the presence of two cointegrating vectors, indicating a stable equilibrium relationship. The alpha and beta coefficients shed light on the speed and direction of adjustments, emphasizing how the system corrects deviations from the equilibrium relationship. Various model selection criteria, including the Akaike Information Criterion (AIC) and Bayesian Information Criterion (BIC), validate the VECM's efficacy in capturing the complexities of these markets while maintaining model simplicity. Moreover, significant error correction terms emphasize the system's self-correcting nature, ensuring long-term stability. Interpreting the coefficients of the lagged terms reveals short-term dynamics, showcasing how coconut oil and crude oil prices mutually influence and respond to changes in one another. The absence of significant autocorrelation in the model's residuals validates the model's accuracy in capturing underlying dynamics.