Volatility spillover effect study in U.S.

dollar and gold market based on bivariate-BEKK

model
Pung Yean Ping, Maizah Hura Binti Ahmad, and Norazlina Binti Ismail

Citation: AIP Conference Proceedings 1750, 060006 (2016); doi: 10.1063/1.4954611

View online: https://doi.org/10.1063/1.4954611
View Table of Contents: http://aip.scitation.org/toc/apc/1750/1
Published by the American Institute of Physics

Articles you may be interested in

Modelling world gold prices and USD foreign exchange relationship using multivariate GARCH model
AIP Conference Proceedings 1635, 849 (2014); 10.1063/1.4903682
 Volatility Spillover Effect Study in U.S. Dollar and Gold
Market Based On Bivariate-BEKK Model

Pung Yean Ping1, a), Maizah Hura Binti Ahmad1, b) and Norazlina Binti Ismail1, c)

1
Department of Mathematical Sciences, Faculty of Science, Universiti Teknologi Malaysia,
81310 Johor Bahru, Malaysia.

a)
Corresponding author: pyppung@yahoo.com
b)
maizah@utm.my
c)
i-norazlina@utm.my

Abstract. As the interaction between international and domestic financial markets increases, the interaction between gold
market and financial markets also increases. Today, the financial attributes of gold play a more evidence role in
dominating the gold price. Taking into account time-varying and dynamic properties of volatility spillover effect in the
financial markets, this paper investigates the time-varying volatility relationship between gold markets and U.S. dollar by
using the bivariate-BEKK. This paper also investigate whether gold volatility is significantly affected by its own pre-
fluctuations, its aggregation and lasting properties, and the bi-directional volatility spillover between the gold market and
U.S. dollar.
Keywords: bivariate-BEKK; gold prices; U.S. dollar; volatility spillover
PACS: 05.45.Tp; 89.65.Gh; 89.65.Gh; 88.05.Lg

INTRODUCTION
Volatility is a condition where the conditional variance changes between extremely high and low values. In the
financial market, knowing how much one variable will change in respond to a change in some other variable is
helpful. Analyzing the size of the error of a model is part of a forecasting procedure. This study analyzes the
volatility movements and interactions between the gold price and U.S. dollar stock market. The U.S. dollar stock
market is the most influential market in the world [1].
From the history, gold and silver were used as currencies in the past. The U.S. dollar became a true fiat currency
in the early 1970s. Many foreign banks hold U.S. dollar as a reserve currency. They considered gold as global
currency. They invested more in gold to reserve their asset during the volatile economic conditions. Gold is
identified as a hedge against fluctuations in the U.S. Dollar market. In the past, when the USD rates went down, the
gold prices remained. Investors will buy more gold to protect their money when the U.S. dollar weakens. But when
the U.S. dollar strengthens, investors will invest in U.S. dollar and abandon gold. There is a negative relationship
between gold and U.S. dollar.

Gold and U.S. Dollar Interactions

Gold is a rare metal used as money. The gold standard was used since 1900. During that time, the value of a unit
of currency was tied to a specific amount of gold. The currency used was U.S. dollar. Gold and the U.S. dollar were
associated and valued based on supply and demand. Gold is considered as a hedge against inflation. The fluctuation
of gold price is affected by many factors and the U.S. dollar index is one of them. In the literature, gold was reported
to be correlated with many assets especially with U.S. dollar. When the gold price goes down, U.S. dollar goes up

Advances in Industrial and Applied Mathematics

AIP Conf. Proc. 1750, 060006-1–060006-8; doi: 10.1063/1.4954611
Published by AIP Publishing. 978-0-7354-1407-5/$30.00

060006-1
and vice versa. Both of them are strongly correlated. Thus, gold plays as an investment asset for investors with low
risk compared with the foreign currency. Gold prices forecasts are important to financial market. Gold prices
however, change rapidly from period to period. In short, they are not constant. The change is not only in the mean,
but also in the variability of the gold prices series. Investors in gold should understand the close relationship
between gold price and the value of U.S. dollar so as make the most of their investments.
Gold and U.S. dollar have a strong relationship. Figure 1 shows the U.S. dollar and gold price form year 2000 to
year 2015. At year 2008 and 2012, there is a support or resistance level breakout in gold and followed by a support
or resistance level breakout on U.S. dollar and vice versa. Figure 1 shows that they form an opposite signal almost at
the same time. The fluctuations of U.S. dollar are likely to affect the price of gold. As the U.S. dollar rises, the gold
price falls and vice versa. This shows that gold price is inversely fluctuated with U.S. dollar. The relationship is not
observable in short period but is in more than ten years’ time. The price of gold and the U.S. dollar Index had a
strong negative relationship [2].

Gold Price VS USD Index

Gold Price USD Index

700.0 140
Gold price per troy ounce (USD)

600.0 120

500.0 100

USD Index
400.0 80

300.0 60

200.0 40

100.0 20

0.0 0

Date

FIGURE 1. Gold price in U.S. dollar unit per troy ounce and U.S. dollar index from January 2000 to May 2015.

Volatility Spillover
As the global economy continues to develop, the expanding in financial freedom, the link between financial
market information dissemination and the growing in liquidity and market operations, the relationship of every
country in financial markets become closer and the markets rate variability cooperative also increase. The price
changes occur when a market subject to risks impact. In essentials, other markets may follow it changed. For
example, if Australia stock market subject to risks impact, Japanese, China and Korea market follow it changed.
Moreover, investors will predict the price changes based on the changes in other market prices, leading to other
markets could eventually change with that market, which is called the "spillover effect."
The time series relationship between the gold and U.S. dollar is worthy of examination besides the price and
return series co-movements analyses. This is because volatility transmissions among them are important and it can
explain the flow of information among gold and U.S. dollar markets. Volatility spillover is the process in which
volatility in one market affects those of other markets.
In the analysis of daily stock market returns of Australia, Hong Kong, Japan, France, Canada, Switzerland,
Germany, US and the UK has been analyzed [3]. The existence of substantial interdependence among the national

060006-2
stock markets with US market was found. Against US innovations, all European and Asia-Pacific markets respond
strongly with a one day lag. Most responses to a shock are completed within two days. By using daily and intraday
price and stock returns data, there are significant spillover effects from the US and the UK stock markets to the
Japanese market but not the other way round [4]. Nevertheless, foreign returns can significantly influence the
domestic returns as in the case of Japan and US [5]. This study finds that cross-market interdependence in returns
and volatilities is bi-directional between the New York and Tokyo markets.
In the study of the magnitude and changing nature of volatility spillovers from Japan and the US to six Pacific-
Basin equity markets, it was found out that regional and world factors are important for market volatility in the
Pacific-Basin region, though world market influence tends to be greater [6]. However, a study found out that the
equity markets of Australia, China, Hong Kong, Malaysia, New Zealand and Singapore are highly integrated with
the stock market in Japan. This indicated that the Asian markets became more integrated over time, especially since
year 1994 [7].
The transmission of equity returns and volatility among three developed markets (Hong Kong, Japan and
Singapore) and six emerging markets (Indonesia, Korea, Malaysia, the Philippines, Taiwan and Thailand) were
examined using multivariate GARCH [8]. The results of the multivariate GARCH model generally indicate large
and positive mean and volatility spillovers, and higher own volatility spillovers than cross volatility spillovers. The
linkages among the stock markets in Warsaw, Budapest, Frankfurt and the U.S. were explored by using a four
variable asymmetric GARCH-BEKK model [9]. The researchers found evidence of return and volatility spillovers
from the developed to the emerging markets while the magnitude of volatility linkages was found to be small. The
co-movements of the regional stock markets of Jamaica, Trinidad, Barbaros and NYSE were analysed using
multivariate GARCH model where significant spillovers were shown to exist between each of the regional
exchanges, as well as from the NYSE [10].
The volatility linkages were shown to exist between India, Singapore and Hong Kong from 1997 to 2005 in a
study using a multivariate GARCH model [11]. These markets show a strong GARCH effect and are highly
integrated. A multivariate GARCH model was also estimated in a study of inter linkages between advanced
economies and EM financial indicators were highly correlated and sharp increases during the crisis period were
discovered. The financial comovements were found between advanced economies and emerging markets during the
subprime mortgage turmoil [12].
In the same direction, the spillovers of the United States to China and Hong Kong for the period 2005-2008 were
using both univariate and multivariate GARCH models [13]. Volatility spillovers from United States to China and
Hong Kong exist, with spillovers from U.S. to Hong Kong being more persistent than those to China. At the same
time, the conditional correlation between China and Hong Kong outweighs their conditional correlations with
United States because of the growing financial integration between these two countries.
In addition, there exist studies that focus exclusively on the co-movements of stock markets in emerging
countries. Trivariate GARCH (1, 1)-in-mean models for 41 emerging markets in Asia, Europe, Latin America, and
the Middle East was estimated and the evidence of mean spillovers in emerging Asia and Latin America and
spillovers in variance in emerging Europe. The cross-market GARCH-in-mean effects is detected [14]. Also, the
level of integration of the BRIC equity markets (Brazil, Russia, India, China) with their respective regions and the
world has studied [15]. Using a bivariate EGARCH model, India shows the highest level of regional and global
integration among the BRIC countries, followed by Brazil, Russia, and China. Lastly, using a bivariate GARCH-
BEKK model, evidence found of mean and volatility linkages between the Eastern European emerging equity
markets (Poland, Hungary, and Czech Republic) and Russia [16].

Bivariate - BEKK
Bivariate GARCH model is a multivariate form of the generalized univariate volatility model. Bivariate GARCH
allows two series, which is to be jointly modeled as a vector ARMA process in both the first moment and second
moment. It can extend the method to include more than two series. Bivariate GARCH models can be estimated as a
constant correlation model or estimated with time-varying correlations.
In BEKK parameterization of the bivariate GARCH model [17], it does not carry out restriction of constant
correlation among variables over time. This model is ensured the H matrix and is always positive definite by
incorporating quadratic forms. The BEKK parameterization for bivariate GARCH model is presented as follows:
ᇱ
‫ܪ‬௧ ൌ ‫ ܥܥ‬ᇱ ൅ ‫ߝܣ‬௧ିଵ ߝ௧ିଵ ‫ܣ‬ᇱ ൅ ‫ܪܤ‬௧ିଵ ‫ܤ‬ᇱ (1)

060006-3
with

ߙଵଵ ߙଵଶ ߚଵଵ ߚଵଶ ܿଵଵ ܿଵଶ

‫ ܣ‬ൌ ቂߙ ߙଶଶ ቃ ǡ ‫ ܤ‬ൌ ൤ߚଶଵ ൨ ǡ ‫ ܥ‬ൌ ቂܿ ܿଶଶ ቃ (2)
ଶଵ ߚଶଶ ଶଵ

In the model, ‫ܪ‬௧ is the conditionl varaince matrix, C is an upper triangular matrix of parameters, B is a 2x2
matrix of parameters which depicts the extent to which current levels of conditional variances are related to past
conditional variances, A is a 2x2 matrix of parameters where conditional variances are related with past squared
errors.
The general bivariate GARCH model is presented as follows:
ଶ ଶ ଶ ଶ ଶ ଶ ଶ
݄ଵଵǡ௧ ൌ ܿଵଵ ൅ ܿଵଶ ൅ ߙଵଵ ߝଵǡ௧ିଵ ൅ ʹߙଵଵ ߙଶଵ ߝଵǡ௧ିଵ ߝଶǡ௧ିଵ ൅ ߙଶଵ ߝଶǡ௧ିଵ ൅ ߚଵଵ ݄ଵଵǡ௧ିଵ 
ଶ
൅ʹߚଵଵ ߚଶଵ ݄ଵଶǡ௧ିଵ ൅ ߚଶଵ ݄ଶଶǡ௧ିଵ (3)

ଶ ଶ
݄ଵଶǡ௧ ൌ ܿଵଶ ܿଶଶ ൅ ߙଵଵ ߙଵଶ ߝଵǡ௧ିଵ ൅ ሺߙଶଵ ߙଵଶ ൅ ߙଵଵ ߙଶଶ ሻߝଵǡ௧ିଵ ߝଶǡ௧ିଵ ൅ ߙଶଵ ߙଶଶ ߝଶǡ௧ିଵ 
൅ߚଵଵ ߚଵଶ ݄ଵଵǡ௧ିଵ ൅ ሺߚଶଵ ߚଵଶ ൅ ߚଵଵ ߚଶଶ ሻ݄ଵଶǡ௧ିଵ ൅ ߚଶଵ ߚଶଶ ݄ଶଶǡ௧ିଵ (4)

ଶ ଶ ଶ ଶ ଶ ଶ
݄ଶଶǡ௧ ൌ ܿଶଶ ൅ ߙଵଶ ߝଵǡ௧ିଵ ൅ ʹߙଵଶ ߙଶଶ ߝଵǡ௧ିଵ ߝଶǡ௧ିଵ ൅ ߙଶଶ ߝଶǡ௧ିଵ ൅ ߚଵଶ ݄ଵଵǡ௧ିଵ  
ଶ
 ൅ʹߚଵଶ ߚଶଶ ݄ଵଶǡ௧ିଵ ൅ ߚଶଶ ݄ଶଶǡ௧ିଵ (5)

where ݄௜௝ǡ௧ is the i-th row and j-th column element of the conditional covariance matrix.

The bivariate BEKK GARCH model is able to capture return and volatility spillover effect of gold and U.S.
dollar index. The parameters of the model are estimated by maximizing the log-likelihood function.

‫ ் ܮ ‰‘Ž ݔܽܯ‬ሺߠሻ ൌ σ்௧ୀଵ ݈௧ ሺߠሻ (6)

்ே ଵ
݈௧ ൌ ݈‫݃݋‬ሺʹߨሻ െ σ்௧ୀଵሺ݈‫ܪ݃݋‬௧ ሻ ൅ ߝ௧ᇱ ‫ܪ‬௧ ߝ௧ (7)
ଶ ଶ

where ߠ denotes all the unknown parameters to be estimated, N is the number of series and T is the number of
observations.

Data Analysis
In this paper, the database consists of daily returns of gold price and U.S. dollar index recorded from January
2000 to May 2015.

060006-4
 FIGURE 2. Return of gold price in U.S. dollar unit per troy ounce and U.S. dollar index from January 2000 to May 2015.

Figure 2 displays the pattern of estimated return series of gold price and U.S. dollar index. Volatility is relatively
high and relatively low which means that an apparent volatility clustering in some periods. The two series are very
volatile during the end of 2008 and the end of 2009. There exist clusters of volatility implying a strong
autocorrelation in squared return.
Table 1 lists the vector autoregression estimates.

060006-5
 TABLE 1: Vector autoregression estimates.

Y2 Y1

Y2(-1) 0.554954 -0.017037

(0.01530) (0.06071)
[ 36.2821] [-0.28065]

Y2(-2) -0.242774 0.045499

(0.01448) (0.05748)
[-16.7618] [ 0.79152]

Y1(-1) -0.087159 -0.009754

(0.00401) (0.01590)
[-21.7570] [-0.61350]

Y1(-2) -0.020206 -0.005919

(0.00423) (0.01678)
[-4.77883] [-0.35274]

C 2.55E-05 0.000364
(4.5E-05) (0.00018)
[ 0.55976] [ 2.01342]

F-statistic 565.9780 0.273009

Log likelihood 17722.40 12212.65
Akaike AIC -8.865350 -6.108408
Schwarz SC -8.857477 -6.100535

In Table 1, the existence of return spillover and information transformation between gold (Y1) and U.S. dollar
index (Y2) are analyzed. The conventional level of significance of 5% is used. The Schwarz and Akaike information
criteria values for the model are -8.857477 and -8.865350 respectively. The low values of Schwarz and Akaike
information criteria implied that the model is good. From the F statistic value, the p values of gold and U.S. dollar
index are 0.273009 and 565.9780 respectively. This implies that the null hypothesis which states lag value of its own
return and cross market return has no impact on its current return is rejected. Return spillover exists between this
two series.
Table 2 tabulates the correlation estimates.

TABLE 2: Correlation estimates.

GOLD USD
GOLD 1.000000 -0.696521
USD -0.696521 1.000000

Form Table 2, the negative values (-0.696521) of correlation means that there is an inverse relationship between
gold and U.S. dollar. This implies that when one variable decreases, the other increases or vice versa. The series
reveals the co-movement of their returns.
Table 3 presents the estimated coefficients in the variance covariance of bivariate BEKK GARCH model.

060006-6
 TABLE 3. Variance covariance estimation.

Coefficient Std. Error z-Statistic Prob.

MU(1) 0.000352 0.000151 2.329088 0.0199

MU(2) -2.25E-05 4.82E-05 -0.465436 0.6416
OMEGA(1) 0.001403 5.93E-05 23.66964 0.0000
BETA(3) 0.950463 0.003278 346.5852 0.0000
BETA(1) 0.967573 0.001738 556.5704 0.0000
ALPHA(1) 0.219687 0.006246 35.17365 0.0000
ALPHA(3) 0.112738 0.002354 31.62587 0.0001
OMEGA(3) 0.000192 2.89E-05 6.647288 0.0000
OMEGA(2) -2.87E-05 1.69E-05 -1.703330 0.0885
BETA(2) 0.983973 0.001513 650.2673 0.0000
BETA(4) 0.923432 0.002143 425.6575 0.0000
ALPHA(4) 0.163478 0.007423 19.36637 0.0000
ALPHA(2) 0.172302 0.008551 20.14893 0.0000

Log likelihood 29651.23 Akaike info criterion -14.82853

Avg. log likelihood 7.416515 Schwarz criterion -14.81436
Number of Coefs. 9 Hannan-Quinn criter. -14.82350

From Table 3, the previous shock and past volatility for all series are significant. The alpha values are less than
beta values implying that the behavior of variance and covariance is not so affected by the magnitude of past
innovations by value of lagged variances and covariances. The significance of values of beta shows that there exists
volatility clustering. Alpha (2) is significance which implies that volatility spillover from gold to U.S. dollar index.
Therefore, the statistical significant of beta (2) implies that the lagged volatility persistence in gold has a negative
effect on current volatility in U.S. dollar index over time. From the results, we can conclude that there exists
volatility spillover between gold and U.S. dollar index. As for direction, it is from gold to U.S. dollar index. Thus,
the equations of bivariate BEKK GARCH are as follow:

݄ଵଵǡ௧ ൌ ͲǤͲͲͳͶͲ͵ଶ ൅ ͲǤʹͳͻ͸ͺ͹ଶ ߝଵǡ௧ିଵ ଶ

൅ ʹሺͲǤʹͳͻ͸ͺ͹ሻሺͲǤͳͳʹ͹͵ͺሻߝଵǡ௧ିଵ ߝଶǡ௧ିଵ ൅ ͲǤͳͳʹ͹͵ͺଶ ߝଶǡ௧ିଵ
ଶ
൅
ଶ ଶ
ͲǤͻ͸͹ͷ͹͵ ݄ଵଵǡ௧ିଵ ൅ ʹሺͲǤͻ͸͹ͷ͹͵ሻሺͲǤͻͷͲͶ͸͵ሻ݄ଵଶǡ௧ିଵ ൅ ͲǤͻͷͲͶ͸͵ ݄ଶଶǡ௧ିଵ (8)

ଶ
݄ଵଶǡ௧ ൌ ሺͲǤͲͲͳͶͲ͵ሻሺͲǤͲͲͲͳͻʹሻ ൅ ሺͲǤʹͳͻ͸ͺ͹ሻሺͲǤͳ͹ʹ͵Ͳʹሻߝଵǡ௧ିଵ
൅ ൫ሺͲǤͳͳʹ͹͵ͺሻሺͲǤͳ͹ʹ͵Ͳʹሻ ൅ ሺͲǤʹͳͻ͸ͺ͹ሻሺͲǤͳ͸͵Ͷ͹ͺሻ൯ߝଵǡ௧ିଵ ߝଶǡ௧ିଵ
ଶ
൅ ሺͲǤͳͳʹ͹͵ͺሻሺͲǤͳ͸͵Ͷ͹ͺሻߝଶǡ௧ିଵ ൅ ሺͲǤͻ͸͹ͷ͹͵ሻሺͲǤͻͺ͵ͻ͹͵ሻ݄ଵଵǡ௧ିଵ
൅ ൫ሺͲǤͻͷͲͶ͸͵ሻሺͲǤͻͺ͵ͻ͹͵ሻ ൅ ሺͲǤͻ͸͹ͷ͹͵ሻሺͲǤͻͺ͵ͻ͹͵ሻ൯݄ଵଶǡ௧ିଵ 
൅ሺͲǤͻͷͲͶ͸͵ሻሺͲǤͻͺ͵ͻ͹͵ሻ݄ଶଶǡ௧ିଵ (9)

݄ଶଶǡ௧ ൌ ͲǤͲͲͲͳͻʹଶ ൅ ͲǤͳ͹ʹ͵Ͳʹଶ ߝଵǡ௧ିଵ ଶ

൅ ʹሺͲǤͳ͹ʹ͵ͲʹሻሺͲǤͳ͸͵Ͷ͹ͺሻߝଵǡ௧ିଵ ߝଶǡ௧ିଵ ൅ ͲǤͳ͸͵Ͷ͹ͺଶ ߝଶǡ௧ିଵ ଶ
ଶ ଶ
൅ͲǤͻͺ͵ͻ͹͵ ݄ଵଵǡ௧ିଵ ൅ ʹሺͲǤͻͺ͵ͻ͹͵ሻሺͲǤͻʹ͵Ͷ͵ʹሻ݄ଵଶǡ௧ିଵ ൅ ͲǤͻʹ͵Ͷ͵ʹ ݄ଶଶǡ௧ିଵ  (10)

Figure 3 presents the estimation of conditional variance covariance by bivariate BEKK GARCH.

060006-7
 .0010

.0008

.0006

.0004

.0002

.0000

-.0002
2000 2002 2004 2006 2008 2010 2012 2014

VAR_Y1 VAR_Y2 COV_Y1Y2

FIGURE 3. Estimation of conditional varaince covariance.

CONCLUSION
In this paper, the co-movement and volatility spillover are shown to exist between gold and U.S. dollar index.
The existence of volatility spillover between gold and U.S. dollar index was shown by using Bivariate BEKK
GARCH. There exists negative shocks and volatility spillover from gold to U.S. dollar. Gold price is inversely
fluctuated with U.S. dollar. Thus, we can conclude that the price of gold and the U.S. dollar Index had a strong
negative relationship.

ACKNOWLEDGMENTS
This work was supported by RUG Vot No: Q.J130000.2526.08H46. The authors would like to thank Universiti
Teknologi Malaysia (UTM) for providing the funds and facilities.

REFERENCES
1. C. K. Elwell, CRS Report R41887 (2011).
2. J. F. Jaffee, Financial Analysts Journal 45, 53–59 (1989).
3. C. S. Eun and S. Shim, The Journal of Financial and Quantitative Analysis 24, 241–256 (1989).
4. Y. R. Hamao, R. W. Masulis and V. K. Ng, Review of Financial Studies 3, 281–307 (1990).
5. W. Lin, R. F. Engle and T. Ito, The Review of Financial Studies 7, 507–538 (1994).
6. A. Ng, Journal of International Money and Finance 19, 207–233 (2000).
7. R. S. Johnson and L. A. Soenen, Journal of Financial Research 25, 141–157 (2002).
8. A. C. Worthington and H. Higgs, School of Economics and Finance Discussion Papers and Working Papers Series 093
(2001).
9. H. Li and E. Majerowska, Research in International Business and Finance 22, 247–266 (2008).
10. T. Grosvenor and K. Greenidge, Journal of Business, Finance and Economics in Emerging Economies 5, 80–107 (2010).
11. N. Sariannidis, G. Konteos and E. Drimbetas, International Research Journal of Finance and Economics 58, 141–149
(2010).
12. N. Frank and H. Hesse, IMF Working Papers 09/104 (2009).
13. T. Sun and X. Zhang, IMF Working Paper WP/09/166 (2009).
14. Beirne, Caporale, Schulze-Ghattas and N. Spagnolo, Elsevier 11, 250–260 (2010).
15. R. Bhar and B. Nikolova, Global Finance Journal 19, 203–218 (2009).
16. E. Fedorova and K. Saleem, Czech Journal of Economics and Finance 60, 519–533 (2010).
17. Y. Baba, R.F Engle, D. Kraft and K. Kroner, Multivariate simultaneous generalized ARCH (University of California, San
Diego, 1990).

060006-8