Information Spillover Dynamics of the Energy Futures Market Sector: A Novel Common Factor Approach

Abstract

We investigate sector level information spillover dynamics between energy and other futures market sectors using a novel common factor approach. The heteroscedastic principal component common factors are derived for each market sector using the daily returns of 176 leading futures contracts traded globally during the period 2005-2011 and used them in our analysis. We find that energy sector has the highest degree of commonality among the 8 sectors that we studied. Conditional correlations between energy and non-energy futures market sectors are highly persistent. Granger causality tests in mean, variance, and value at risk reveal that the volatility spillover from the energy sector is more prominent than the mean and extreme market risk spillovers. Extreme energy market shocks have an asymmetric effect on some non-energy market sectors. Impulse response analysis reveals that shocks to energy futures have a significant potential impact on other sectors especially during GFC and EUC crisis. The impact of the extreme market events of the energy sector is dominated by WTI oil futures. Consistency of our findings with the existing literature based on individual asset-to-asset spillovers reveals that our results are quite robust. The proposed common factors are important for other applications as well such as benchmark indices in marker sector-specific asset pricing models.