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Assignment for Financial & Time Series Analysis Volatility in Gold Price Returns: An Investigation from International Market

Submitted by- Group -9 Satish Kumar Boywar Vivek Prakash Rohit Gupta IM 19/ Section C IM 19/ Section C IM 19/ Section C Roll no. 146 Roll no. 194 Roll no. 204

Volatility in Gold Price Returns: An Investigation from International Market


Abstract
The research was conducted in order to study the volatility in gold price returns and its investigation. The data has been collected on daily basis for the tenure of a couple of years starting from 1st January 2006 to 1st January 2014. The models used to run the data are; standard deviation as a Descriptive Model, and GARCH as an Econometric Model. The results investigate volatility. Econometrically speaking, an unequal spread of residuals is referred as heteroskedasticity. In this research, a fast mean reversion has been observed showing that the alpha and beta are far from 1. Based on results it was concluded that there has been volatility in gold prices.

1. Introduction
All valued metals, such as Gold is very famous when it comes to investing. Investor buys gold in order to have risk management, namely hedging, against the economic, currency, social and political crises (it includes reduction in markets and the prosperity of the national debt, foreign exchange sufficient for inflation, wars and social issues). Speculation is very common when it comes to the investment of gold, which is the case in other markets, including through the use of futures and derivatives. 1.1 Gold sector resumes net purchases after two decades of sales In the period of 2010, golds net buyer, for the first time in 21 years, were the official sectors. Net official sector sales average was 400-500 tons per year from the year of 1989 to 2007. In 2008, the sales of Central Bank dropped by one half approximately and were continuously declining and became 30 tons in the year of 2009. The official sector holds 18%, as a group, of all above ground stock of gold. However, holding of gold is not equally distributed among nations. The advanced economies of Western Europe and North America typically hold over 40% of the net external reserves in terms of gold, mostly gold standard legacy. Under that regime, countries backed their currencies with gold, which led to the build-up of very large gold reserves among the leading economies of the period. First, emerging market economies that have been going through fast economic success have been the substantial gold buyers. The primary reason for this has been a desire to move toward restoring a prior balance between foreign currencies and gold that has been eroded by the rapid increase in their holdings of foreign currencies, principally the US dollar. For this group of countries, gold has also become an increasingly attractive means of diversifying their external reserves. As a result, emerging market purchases of gold have made a significant impact in reducing the quantity of gold the official sector had been supplying to the market each year. Second, European central banks holding a significant amount of gold in their external reserves have had a reduced appetite for sales in the wake of the financial crisis. Prior to the onset of the

financial crisis, several European central banks initiated gold sales programs in order to rebalance their external reserve portfolios and increase their foreign currency holdings. 1.2 Rapid economic growth in emerging markets has led to large gold purchases In 2010 several emerging market economies made large purchases of gold, led by Russia which purchased 135 tons. Many participants of the market foresee that China might continue buying mine production which would be local. China has a good team of experts from domestic and from overseas advising China to continue the buying of gold. Other emerging country purchases were made by the central banks of Thailand (16 tons), Bangladesh (10 tons), Venezuela (5 tons), and the Philippines (1.4 tons). Economic growth in emerging markets has been very strong over the past decade, and this has resulted in rapid increases in foreign currency reserveseither through expanding export revenues or increased foreign exchange interventions to mitigate the strength of their rising currencies against the US dollar. Both factors are driven by economic growth and contribute to expanding national wealth that policy makers are eager to preserve. Throughout the financial crisis, and now during the continuing sovereign debt concerns, emerging market central banks have increasingly turned to gold purchase programs as a means of diversifying their reserves into an asset with no credit or counterparty risk that provides immediate liquidity in all market conditions. The foreign reserves across all central banks increased from $2 to $10 trillion, yet gold as a percentage of total reserves remained at 13% across all central banks. However, many countries that have fixed or managed exchange rates against the US dollar witnessed a significant decline in their gold holdings in relation to their total reserves as they accumulated more dollars in order to maintain their pegs. Beyond Russias rebalancing efforts, in 2009Indias purchase of 200 tons helped the country toward its goal of restoring the balance between gold and foreign currencies in its total reserves. 1.3 Objective of The Study: To study the volatility of gold prices and its investigation in International markets from 1st January 2006 to 1st January 2014. 1.4 Scope of The Study: By studying and investing the volatility of gold prices we can figure out the reasons due to which there is so much fluctuations in the prices plus what measures can be taken to maintain the price at a certain level. The investigation would tell us how much volatility existed in gold prices during the period. 1.5 Problem Statement: An empirical study to investigate the volatility in gold prices from 1st January 2009 to 1st January 2014. 1.6 Hypotheses:

2. Literature Review
According to Alptekin (2010), the research took into an account when the economy of the world gold market remains its character as a place of conventional investment. As we can see

the up and downs in the gold prices as an indicator of market instability as whole. The research resulted as an alternate investment according to the balance between the supply and demand conditions which affects the economy on a vast scale. In his knowledge it was to examine the empirical study of the instability of gold prices. The instability was tested through ARCH LM test and GARCH (2,1) model. The result shows that the number of gold prices was volatile and volatility was excluded. Baur, (2011) determined that by tradition gold was a stock of worth & an inflation hedge. Gold is also viewed as a hedge against vagueness and a harmless haven. This research proves that numerous possessions usually related with gold are only active in a simple regression outline but significantly alteration in a various regression outline. An expressive and econometric examination of gold and US monetary and financial variables for once-a-month data from the period of 1979 - 2011 authenticates that gold chiefly helps as a hedge against a gentle US dollar and against advanced commodity amounts. Gold is not a hedge against consumer rate inflation. The observed outcome even displays that gold only lately progressed as a harmless harbor asset. According to Baur, (2009) The reason of this paper is to observe the part of gold of worldwide monetary scheme. We examine theory; gold indicates a harmless harbor in contrast to shares, primary of emerging economies. A expressive analysis for the illustration of thirty years ; 1979-2009 displays; gold as a harmless harbor used for chief European stock markets & the United States but not for Australia, Canada, Japan & massive developing marketplaces like BRIC nations. We even differentiate between a fragile and durable form of the harmless harbor and argue that gold may act as a stable strength for the monetary structure by decreasing sufferers with the face of great undesirable marketplace tremors. Bhanot, 2006 concluded the trading of C.E Divisions gold and silver futures contract was boosted on Chicago Mercantile Exchanges Globex electronic trading arrangement, as a fight-back against the framework of copies of these agreements from the Chicago Board of Trade. The COMEX detected an instant stream and stable advance in market share, while market shares of the electronic CBOT and open outcry COMEX reduced. The market worth for normal and mini-sized contracts is greater to that of their pit-traded counterparts. Irrespective of dropping volume share, the CBOT has a like market excellence circumstances to the COMEX. The theoretic models of multimarket trading suggest that a translucent electronic limit order market improves market value in whole. Also, the central market rises as a significant midpoint for trading volume. According to Bordo in 2007 the typical gold standard has prolonged been related with long run price loyalty. But short-run price inconsistency controlled opponents of the gold standard to mention progresses that seem prominently like modern varieties of price-path targeting. This object has used a dynamic stochastic general equilibrium model to examine price dynamic forces under substitute strategy systems. Here, a clean inflation goal proposals more short-run price dependability than does the gold standard and, though it offerings a unit root into the value level, it hints to as much long-term price reliability as does the gold standard for horizons that are smaller than twenty years. Relation to these structures, Fisher's rewarded dollar decreases inflation vagueness by an order of greatness at all horizons. A Taylor rule tips to excessive ambiguity about inflation at long horizons. This long-run inflation ambiguity can be frequently eradicated by giving an additional response to the unconventionality of the rate level from a wanted path. According to Bordo, 2003 , in this research the old gold standard had being long related with long-run price steadiness and short run price. The short run price instability has directed the censors to recommend modifications that have observed ample like modern varieties of pricepath leveling. This paper had used an actual stochastic overall steadiness model in order to study price dynamics under alternate policy. In the model, an inflation aim offers more shortrun value steadiness than does the gold standard and, though it grants a unit root into the price

level, and even it has engaged to as much long-term price reliability as does the gold standard for horizons which are shorter than 30 years. Fisher's reimbursed dollar decreases price level and inflation vagueness by an order of scale at all horizons. The traditional gold standard has long been linked with long-run price steadiness. But short-run price indiscretion led censors to suggest expansions that look typically like modern types of price-path targeting. This examination has used a vibrant stochastic overall equilibrium model to examine price dynamics under extra policy structures. Here, an inflation target delivered more short-run price constancy than does the gold standard and, though it grants a unit root into the price level, it hints to as much long-term price constancy as does the gold standard for horizons smaller than thirty years. Fisher's rewarded dollar decreases price level and inflation vagueness with an order of greatness at altogether prospects. According to Chernyshoff (2007) this study is an acceptance of the gold standard strengthens or contracts macroeconomic unpredictability. Followers believed so, critics believed not, and theory deals indistinct infrastructures. A rigid exchange-rate system like the gold standard might edge monetary jolts if it ties the hands of policy makers. But any conclusion to leave exchange-rate elasticity might conciliation shock preoccupation in a world of real shocks and insignificant stickiness. A simple model displays how an absence of elasticity can be eminent in the broadcast of standings of trade shocks. Indication on the association between real exchange rate unpredictability and terms of trade variability from the late nineteenth and early twentieth century discoveries a pretentious alteration. The old-style gold standard engrossed shocks, but the interwar gold standard didnt, and this past pattern suggests that the interwar gold standard wasnt a upright rule assortment. According to Coudert (2011) in this investigation, they look into the role of gold as a harmless haven. They stretched the current writings in 2 means. First, they study crunch stages consecutively distinct by recessions and bear markets. Second, ARMA-GARCH-X model has been used to evaluate conditional co-variances between gold and stocks returns. The regressions where run on monthly data for gold and numerous stock market indices. They originated that gold succeeded as being a safe haven against all the stock indexes. The outcome demonstrations that it holds for crunches named as recessions or bear markets, as the covariance between gold and stocks returns is observed as negative or null in all circumstances. According to Demidova-Menzel (2007), this research observes the main forces for gold investment. Since 2000 the prices of gold has increased considerably, considering gold an inspiring add-on to a portfolio. As gold futures have negative roll yields, gold pool books are measured by great credit risk and physical care of gold means great transaction costs, XetraGold may be the greatest well-organized way to enter the market. Xetra-Gold is a creation shaped by the Deutsche Brse in the period of 2007, which is well-ordered like a security but can be switched into physical gold any while. In the portfolio context gold has had a positive inspiration on Euro and USD portfolios between the tenure of 2000 and 2006 because of considerable yields and little correlation to other assets. But, this has not been factual for nearly all other ages, the association was continuously low but the returns of gold were approximately zero, which supersedes the positive alteration consequence. According to Desquilbet, (2004) this research is regularly sustained that (CBs) and (GSs) are alike in that they are rigid monetary rules, the two basic structures of which are great credibility of monetary authorities and the existence of automatic adjustment mechanism. This article contains a comparative analysis of these two types of systems both from the viewpoint of the sources and mechanisms of generating credibility, and the elements of operation of the automatic adjustment mechanism. Confidence under the GS is endogenously driven, while it is exogenously determined under the CB. CB is a much more asymmetric system than GS although asymmetry is a typical feature of any monetary system. The absence of credibility is

typical for peripheral nations and cannot be overcome totally even by hard monetary systems. Hammoudeh (2010) has determined that in this paper volatility and correlation dynamics in price returns of gold, silver, platinum and palladium explores the corresponding risk management implications for market risk and hedging. VaR examines the downside market risk linked with investments in valuable metals, and to design ideal risk management policies. They figured the VaR for chief valuable metals using the calibrated Risk Metrics, different GARCH models, and the semi-parametric Filtered Historical Simulation approach. Different risk management tactics are recommended, and the finest methodology for calculating VaR based on conditional and unconditional statistical tests is acknowledged. The economic importance of the consequences is emphasized by considering the daily capital charges from the projected VaRs. The risk-reducing portfolio weights and dynamic hedge ratios between different metal groups are also examined. Acording to Kearney, 2008. Nearby 90% of the decrease in gold prices over the decade of the 1990s - from $393 in the beginning of 1990 to $286 in early 2000 - occurred after early 1995. Whereas gold prices were dropping, the usage of derivative instruments by the gold mining industry improved promptly. Conventionally, such activity would not be expected to affect gold prices. In this paper, we examine the likely influence of derivatives on the gold market. The research results propose that the use of derivatives by gold producers, whether it was to hedge against the risk of decreasing gold prices probably pushed gold prices below what they would have been based upon historical contacts. Conversely, when gold producers reduced their net derivative positions over the April 1999:IV to January 2006 period, this de-hedging seems to have helped improved gold prices back toward levels stable with longer run fundamentals. Kearney, (2009) has concluded in this paper that gold and platinum prices are positively linked over 1985-2006. So far, over smaller sample stages the link fluctuates from positive to negative in the period of 1996-2001 and back. The purpose of this research was to analyse whether this shift is the result, at least in part, of the rapid increase in forward sales by gold producers, which led in the influence of considerably dropping gold prices in the second half of the 1990s. The non-neutral short run impacts of derivatives on gold prices. The outcomes demonstrates decreasing gold prices are related with great net upsurges in forward sales, whereas increasing gold prices are linked with decreasing forward sales or producer dehedging. According to Marzo, (2010), they have examined how the connection of gold prices and the U.S. Dollar had been impacted by the current chaos in financial markets. They have used spot prices of gold and spot bilateral exchange rates against the Euro and the British Pound to analyze the pattern of instability spillovers. They have also projected the bivariate structural GARCH models planned by Spargoli e Zagaglia (2008) to gauge the causal links of instability fluctuates in the two assets. They also applied the tests for change of codependence of Cappiello, Gerard and Manganelli (2005). They recognized the capability of gold to produce constant co movements with the Dollar exchange rate which have endured the latest levels of market disruption. Their results even disclosed that exogenous rise in market insecurity have inclined to generate reactions of gold prices that are extra steady than those of the U.S. Dollar.

3. Methodology
In order to investigate the volatility in International gold markets, gold prices data consists of daily observation from January 1st 2006 to 1st January 2014 will be considered. We will be studying and analyzing the volatility in gold price returns, for this we will be referring different books on economics, research plans and articles, magazine, newspapers. However, data will be collected from internet. We will also gather quantitative data and will try to

present it in the most appropriate manner and for that We will be using GARCH model, charts, tables and different graphs and use of SPSS and Microsoft Excel software. 3.1 Data and Variables To conduct this research, secondary data is collected. The data has been retrieved from daily frequency. Variable in this study are the gold prices. 3.2 Sample The time that will be focused for the sample is 1st January 2006 to 1st January 2014. 3.3 Models The models which will be used to conduct this study are; Descriptive Model and Econometric Model. 3.3.1 Gold Return Since we are observing daily data of gold , we are going to get daily log returns for the markets incorporated in our sample. The formulation for log returns is:

where, Rt = gold returns at timet Pt = gold price at timet Pt-1 =gold price at 1st lag of timet. 3.3.2. Measures of Dispersion state how spread out the facts is around the mean. Measures of dispersion are specifically supportive when data are normally distributed, i.e. thoroughly look like the bell curve. The utmost mutual measures of dispersion follow. 1. Variance is specified as the addition of the squares of the differences between each observation and the mean, that amount is divided with the sample size. For populations, its considered with the square of the Greek letter sigma ( ). For samples, its considered as the square of the letter s ( ). Consequently it is a quadratic appearance, i.e. a number upraised to the second power, variance is the 2nd moment of statistics. Variance usage isnt much common than standard deviation. It can be used if we want to subordinate the contradiction of two or more sets of interval data. The more the variance, the more spread out the data. Formula for sample population:

2. Standard deviation is stated as the positive square root of the variance, i.e. for populations and s for samples. Basically it is the average difference among observed values and the mean. The standard deviation is used when stating dispersion in the a like units as the original measurements. It is used more commonly than the variance in testifying the degree to which data are spread out. Standard deviation is a widely used measurement of irregularity used in statistics and probability theory. It shows how much dissimilarity there is from the "average" (mean, or expected value). A low standard deviation specifies that the data points tend to be very close to the mean, while high standard deviation specifies that the data are spread out over a great range of values. Hypothetically, the standard deviation of a statistical population, data set, or probability distribution is the square root of its variance. It is algebraically easier however virtually less strong than the average absolute deviation. A beneficial feature of standard deviation is that, not like variance, it is articulated in the same units as the data. Standard deviation is frequently used to measure confidence in statistical inferences. In science, researchers usually report the standard deviation of experimental data, and only effects that fall far outside the range of standard deviation are measured statistically significant normal random error or disparity in the measurements is in this way notable from causal disparity. Standard deviation is also very important in finance, where the standard deviation on the rate of return on an investment is a measure of the volatility of the investment. Formula for sample population;

Where; s=sample standard deviation n= sample size x= observations 3.3.3 Econometric Analysis 3.3.3.1 GARCH (p,q) Model Generalized Autoregressive Conditional Heteroskedasticity model was revealed by Bollerslev (1986). The GARCH volatility function shows the results of a GARCH stochastic, or random, unpredictability model as applied to a historical time series of the price of an asset. GARCH can be used to assess the impulsiveness of bonds, stocks, currency exchange rates, funds returns or commodities. GARCH supports to examine for patterns of inconsistency between the historical volatility and the implied volatility. Such inconsistencies can suggest chances for instability trading. GARCH can also be used for foreseeing variance study. GARCH is a statistical model used by financial institutions to evaluate the instability of stock yields. These facts are used by banks to help conclude what stocks will possibly deliver greater earnings, also to estimate the yields of existing investments to help in the planning procedure. There are several variations of GARCH, that includes NGARCH correlation, and also IGARCH that limits the unpredictability parameter. Each model can be used to accommodate the definite qualities of the stock, industry or economic state. In that situation, the GARCH (p, q) model (where p is the order of the GARCH terms and q is the order of the ARCH terms ) is given by

GARCH (1,1) model specification The Generalised Autoregressive Conditional Heteroskedasticity model was developed independently by Bollerslev in 1986. There are 2 dispersed lags used to clarify inconsistency under GARCH models, one on past squared residuals to capture great frequency effects or news about volatility from the earlier period measured as lag of the squared residual from mean equation, and second on lagged values of variance itself, to have long term influences For GARCH (1, 1):

Where:

In the GARCH (1, 1) model, the variance probable at any given data is a mixture of a long run variance and the variance probable for the previous period, adjusted to take into account the size of the previous periods detected shock. In the GARCH model estimates for financial asset yields data, the sum of coefficients on the lagged squared returns and trailing conditional variance is very near to one. This infers that shocks to the conditional variance will be extremely persistent and the occurrence of quite long remembrance but being less than one it is still mean reverting. Although instability takes a long time, it eventually gets back to the mean level of instability, just like a pendulum which detects and moves to and fro motion about its mean position. It infers that existing information has no effect on long run forecast. Long run average variance is that is only relevant when

4. Result and Discussion 4.1 Gold Price Return chart


Daily Returns 30.0% 20.0% 10.0% 0.0% -10.0% -20.0% -30.0% -40.0%

Standard Deviations : 10-day MA s(k) 16.0% Actual 10-day MA Standard Deviation 14.0%
12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0% Sep/06 Sep/07 Sep/08 Sep/09 Sep/10 Sep/11 Sep/12 Sep/13 Mar/06 Mar/07 Mar/08 Mar/09 Mar/10 Mar/11 Mar/12 Mar/13

Aug 20/08 - Jan 20.0% 15.0% 10.0% 5.0% 0.0%

100 market-day window

The above graphs show unequal spread (variance) for Gold Prices from 1st January 2006 to 1st January 2014. Econometrically speaking, unequal spread of residuals is referred to as hetroskadastity. 4.2 Econometric Analysis GARCH (1, 1) is applied through software. All three parameters of GARCH (1, 1) model are significant for all markets as which means long run variance, 1st lag square returns, and trailing variance are significantly explaining the conditional variance. GARCH(1,1) estimation of Gold Price Returns Omega = 3.33902299574238E-06 Alpha = 0.1034 Beta = 0.8910 All coefficients that are omega, alpha and beta values are significant as t statistics is greater than 2 and probability value is less than 0.05 for all coefficients. Hence, overall the model is significant. Furthermore, the sum of parameters supposed to be either 1 or approaches 1. W 0.000003 a 0.1034 B 0.8910 a+b 0.9944 w+a+b 0.9944 LRAV 0.014457

Long run average variances (LRAV) for the gold price returns are also calculated (using which has derived 0.014457 which is 1.4457% of LRAV. Since the sum of coefficients for both market returns is less than 1, which is required to have a mean reverting variance process. The process of mean reversion gets slower, as the sum of coefficients gets closer to 1. As result shows that highest mean reversion value, that is 0.978. 5. CONCLUSION Yes! There is volatility. From the test it shows a significant result and a positive sign that volatility exists. While the econometric debate on the short range or long range nature of dependence in uncertainty still goes on and it might never come to an end but these financial models provides with a motivation to analyze the volatility and hence providing a useful complement to econometric analysis and more research needed to make a complete conclusion and recommendation that be given to the investor and reader. After being a source of significant supply, central banks became net buyers in the gold market in the year of 2010. Emerging market economies that have been going through fast economic success have been the substantial gold buyers in order to diversify the external reserves. In the intervening time, central banks of Europe, which for two decades had been selling gold, have almost, clogged their sales in the wake of the financial European sovereign debt crunches. These two forces have considerably reduced the supply of gold to the market. The official sector tends to be highly risk averted and even the public remains concern all the time regarding the fiscal and monetary conditions, any sales of gold, especially from the progressive economies are likely to remain small. Meanwhile, emerging markets continue to build large external reserves, to provide them with security in the face of ever challenging market conditions. With the importance of gold universally reaffirmed by central banks, developing economys central banks are expected to endure buying Gold in order to conserve states treasure and to promote better market stability financially. Central banks continues to be dedicated to the significance of gold and its importance in upholding strength and sureness as they have been for many years.

6. Areas of Further Research


Having conducted this research has given a valuable insight yet certain areas supposed to be incorporated, these are: To incorporate leverage effect by applying many other financial and economic model. Impact of Gold prices on Inflation and with global stock market. To compare volatility in bullish and bearish trend of different time eras. To follow exponential smoothening techniques and forecast how would or it might react due to economic role. Investigate the Supply and demand of gold in detail.