Energy Economics 117 (2023) 106446

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

Stochastic ordering of systemic risk in commodity markets✩

Giacomo Morelli
Department of Statistical Sciences, Sapienza University of Rome, 00185 Rome, Italy

ARTICLE INFO ABSTRACT

JEL classification: The contribution of commodity risks to the systemic risk is assessed in this paper through a novel approach
C46 that relies on the stochastic property of concordance ordering of CoVaR. Considering the period that spans
C54 from 2005 to 2022 and the VIX as the proxy for the stability of the financial system, we build the stochastic
C58
ordering of systemic risk for 35 commodities belonging to four sectors: Agriculture, Energy, Industrial Metals,
Q02
and Precious Metals. The estimates of the 𝛥CoVaR signal that contagion effects from commodity markets to
Keywords: the financial system have been stronger during the years 2017–2019. Backtests validate CoVaR as a more
Systemic risk resilient risk measure than the VaR, especially during periods of market turmoils. The stochastic ordering of
Commodity markets
CoVaR shows that severe losses (downside risk) in commodity markets tend to exacerbate systemic financial
Stochastic ordering
distress more than gains (upside risk). Commodity risks arising from WTI and EUA are threatening triggers for
CoVaR
VIX systemic risk. In contrast, the financial system is less vulnerable to a broader range of scenarios arising from
fluctuations in Gold prices. As top contributors to the systemic risk, among the sectors we find Energy and
Precious Metals with respect to upside risk and downside risk. The Covid-19 crisis has deeply amplified the
systemic influence arising from the downside risk of WTI, Gasoline, and Natural Gas UK and has confirmed
the safe-haven role of Gold.

1. Introduction Modelling commodity risks is challenging. The intense interaction

The financialization of commodity markets (Basak and Pavlova,
2016) has brought the attention of risk managers and regulators to the
assessment of the contribution of commodity risks to the instability of
the financial system. For instance, the Basel Accords establish a mini-
mum capital standard to cover the risk of holding or taking positions
in commodities, and impose each bank subject to capital charges for
market risk to measure, monitor, and report the level of commodity
risk against which a capital requirement needs to be set aside (Basel
Committee on Banking Supervision, 2011). More recently, the Euro-
pean Securities and Markets Authority (2021b) has proposed position
limits on commodity derivatives to reinforce the establishment of risk
management applications to monitor the impact of commodities on
the systemic risk (Acharya, 2009; Acharya et al., 2012; Brownlees and
Engle, 2017). In the context of quantitative macro-prudential policy, it
is of primary importance to develop modelling frameworks that capture
the realistic features of commodity markets and unequivocally identify
the main threats to the stability of the financial system (The European
Central Bank, 2009). However, a robust methodology that ranks the
contributions of commodity risks to the systemic risk has not been
provided yet. This is the objective of our paper.
between trades and the supply/demand imbalances that stem from
the business cycle, political events, and weather conditions (Giot and
Laurent, 2003) contributes to commodity price fluctuations. Moreover,
the intertwined connections (Diebold et al., 2017; Balli et al., 2019)
that arose between commodity markets and other markets with the
financialization of the commodities (Prokopczuk et al., 2019) increase
the complexity of this task. The manifold drivers of the commodity risk
call for a procedure that relates the movements in the commodity prices
to the associated risk measures that serve as barometers for financial
stability.
We forge an empirical framework for commodity markets thriving
from the theoretical result in Mainik and Schaanning (2014), that
establishes the property of concordance ordering of Conditional Value-
at-Risk (CoVaR). Relying on this property, we adopt the definition of
CoVaR with conditional event the stress scenario described by the log-
returns exceeding the VaR as opposed to Tobias and Brunnermeier
(2016). The novelty of our work entrenches the use of stochastic
dominance to order the contribution of commodity markets to the
systemic risk, addressing the following issues. How can we identify the
main threats to the financial system within commodity markets? Can

✩ I am greatful to the Editors and two anonynous reviewers for the quality of their reports and insightful suggestions that this paper benefited. I thank seminar
participants at Sapienza University of Rome 2021, EURO 2021 (Athens), ICEF 2021 (Xiamen), CEMA 2021 (Madrid), EFI 7 (Napoli) conferences.
E-mail address: giacomo.morelli@uniroma1.it.

https://doi.org/10.1016/j.eneco.2022.106446
Received 24 January 2022; Received in revised form 23 September 2022; Accepted 24 November 2022
Available online 16 December 2022
0140-9883/© 2022 Elsevier B.V. All rights reserved.
G. Morelli
we provide the regulator with a clear assessment of the ranking of the
impact of commodity risk on the systemic risk?
We answer these questions basing the analysis on commodity fu-
tures prices available from Bloomberg (2018), spanning the period
from 2007 to 2018. Futures prices reflect potentially informative eco-
nomic outlooks embodying investors’ fear of hazards in commodity
markets (Fernandez-Perez et al., 2020). Such additional informative
content allows us to capture the contribution of commodity markets to
the systemic risk as perceived by the market. To proxy the stability of
the financial system, we refer to the volatility retrieved from the current
prices of options written on the S&P500 Index and aggregated into the
level of the Chicago Board Options Exchange Volatility Index (VIX). By
construction, the VIX provides a reliable measure of the expectation
of stock market volatility over the next 30 calendar days (Whaley,
2009). Several crisis events have shown that the distress of structural
components of the financial market amplifies volatility and the risk
of financial contagion (Mieg, 2020). For this reason, we represent the
stability of the financial system through the behaviour of the VIX.
Among others, the study in Silvennoinen and Thorp (2013) supports
our choice observing a higher commodity-stock correlation when the
VIX increases.
Our analysis proceeds in two parts. In the first part, we compute
daily estimates of the CoVaR for the portfolios representing the com-
modity sectors Agriculture, Energy, Industrial Metals, Precious Metals,
and for four of the most traded commodities. The portfolio weights are
daily re-balanced, considering the Expected Shortfall (ES, Rockafellar
et al. (2000)) as the utility function minimized in the portfolio opti-
mization problem and thus responding to the risk management goal
of investors to hedge severe losses. We capture typical stylized facts of
financial time series, such as skewness, kurtosis, and the leverage effect
in the portfolio choice exploiting non-linear GARCH models. Among the
most popular specifications, we choose the exponential GARCH model
(E-GARCH) of Nelson (1991) and the GJR model introduced in Glosten
et al. (1993). In particular, we select for each commodity the combi-
nation of the GARCH specification and underlying distribution of the
residuals that provides parsimony and high goodness of fit. We include
the standard GARCH (sGARCH) model as a benchmark and consider the
following distributions: Normal ( ), Skewed-Normal ( ), Student’s-
t ( ), Skewed-Student’s-t ( ), and Generalized Hyperbolic (). To
generate the probability density function (pdf) required for the compu-
tation of the time-varying CoVaR, we estimate the correlation matrix
and the conditional means of the returns fitting the Dynamic Condi-
tional Correlation (DCC) model (Engle, 2002) on the joint distribution
of the returns of the VIX and commodity sectors. Finally, we validate
the CoVaR obtained through backtesting procedures.
In the second part of the analysis, we provide the stochastic ordering
of the CoVaR of the commodities and the four sectors over the entire
sample period. For this more general representation of the systemic risk
in commodity markets, we select the distribution that better captures
the stylized facts of the commodities and the VIX and estimate the
parameters of such distribution through Maximum Likelihood.
Our findings can be summarized as follows. First, commodities
exhibit different types of leverage effects conveniently captured using
E-GARCH models that provide more flexibility than the GJR counter-
parts. Second, the ES of the commodity sectors portray Agriculture as
the weakest contributor to the systemic risk. Third, daily estimates of
the CoVaR are greater than those of the VaR of the VIX for most of the
period examined. Rises in Energy prices primarily affect the stability of
the financial system during the global financial crisis (GFC) in 2007–
2009 and the vulnerability induced by financial distress in Precious
Metals increases during the Covid-19 crisis. Fourth, results on backtests
support the use of CoVaR to build up capital requirements depending
on the degree of distress of the financial system. Fifth, the stochastic
ordering of the CoVaR for the commodities reveals that returns losses
(downside risk) influence more the stability of the financial system
than gains (upside risk). Crude Palm Oil, Rapeseed, and Tin show the
2
Energy Economics 117 (2023) 106446
most substantial asymmetric effects between the contributions of the
related downside and upside risks to the systemic risk. The downside
and upside risks arising from WTI and EUA represent the major drivers
of systemic distress occupying the first positions in both the stochastic
orderings, whereas drops and rises in Gold prices poorly influence
system risk compared to the other commodities. The estimates of
CoVaR for the commodity sectors are more homogeneous compared to
those for the commodities, suggesting that the portfolio optimization
evens the existing discrepancies in commodity risks. In particular, the
minimization of the ES remarks the difference between the CoVaR
computed from financial distress triggered by downside and upside
risks. The top contributors among the commodity sectors are Energy
and Precious Metals with respect to upside and downside commodity
risk. We assess the impact of the Covid-19 outbreak on the systemic
risk in commodity markets building the stochastic ordering as of March
6, 2020, the last date available before the first remarks on Covid-19
were announced by the World Health Organization (WHO).1 We find
that EUA was established as a systemic menace before the Covid-19
outbreak. After the shock event, the systemic influence arising from the
downside risk of WTI, Natural Gas UK, and Gasoline is amplified. The
safe-haven properties of Gold are identified by the remarkably lower
position in the rankings compared to the pre-Covid-19 period and the
weaker contribution to the systemic risk.
Through this analysis, we explore the extent to which equity and
commodity markets are inter-dependent, capturing the major chan-
nels of the propagation of market risk among commodity markets
using well-established systemic risk measures. Similarly to Bekiros
et al. (2017), we find that scenarios of financial distress for WTI
alter the stability of the financial system. However, WTI is not the
only remarkable contributor to the systemic risk. We also find this in
other Energy and Agricultural commodities. From the methodological
perspective, Algieri and Leccadito (2017) employ the Delta CoVaR
(𝛥CoVaR) to assess the contagion risk from the commodity markets
of Oil, Metals, Agriculture, and Ethanol to the whole economy. Their
ranking of contagion risk is established ordering the p-values for the
null hypothesis, 𝛥𝐶𝑜𝑉 𝑎𝑅𝑠|𝑖 ≤ 𝛥𝐶𝑜𝑉 𝑎𝑅𝑠|𝑗 , where 𝑠 is the S&P500 and
𝑖, 𝑗 are commodity markets. Considering three different significance
levels for the computation of CoVaR, the ranking does not change when
assessing the reaction to both peaks and downturns of the prices of the
indices. One pitfall of this approach is that the ranking obtained does
not account for the consistency of systemic risk measures with respect
to stochastic dependence.
Three reasons characterize our work and differ from this analysis.
First, we build the stochastic ordering of CoVaR relying on the mono-
tonic property proved in Mainik and Schaanning (2014), making the
analysis statistically robust. In fact, instead of ranking the p-values
of the statistical test built on 𝛥CoVaR, we directly rank the CoVaR.
Second, our study focuses on 35 commodities instead of the indices
that proxy commodity markets. Third, we shed light on the connections
between commodities through correlations to depict a more complete
picture of the drivers of systemic risk in commodity markets.
The simplicity of our procedure is especially valuable for: (i) in-
vestors, since it increases the transparency of the market, fostering
wiser investment decisions, and (ii) the policy maker, to whom we
provide a map of the spillovers of commodity risks to the systemic risk
to be considered for the correct determination of capital requirements.
Since financial product complexity tends to sharpen macroeconomic
instability (Botta et al., 2020), we attempt to increase the transparency
of the main drivers of systemic risk among commodity markets extract-
ing the underlying information on their market dependencies with the
stochastic ordering of CoVaR. In a similar spirit to Kerste et al. (2015),
1
We choose March 9, 2020 as the beginning of the pandemic since it
represents the first day the World Health Organization releases remarks on
the management of Covid-19 worldwide.
G. Morelli
we also interpret the results considering the necessity of accounting for
the heterogeneity of commodity risks in the regulatory framework.
The rest of the paper unfolds as follows. Section 2 reviews the
literature on the assessment of the systemic risk in commodity mar-
kets. Section 3 unravels the methodology and the application of the
theoretical finding in Mainik and Schaanning (2014). Data descriptions
with the discussion of the empirical results are reported in Section 4.
Section 5 concludes arguing policy implications.
2. Literature review
Commodity risk is defined as the financial risk arising from the fluc-
tuations of commodity prices (Joëts et al., 2017; Basel Committee on
Banking Supervision, 2019). Several studies corroborated the idea that
commodity risk could be integrated to enhance the benefits of portfolio
diversification, ascribing the reason to the negative correlation between
commodities and equity returns, and to the positive correlation with in-
flation (Erb and Harvey, 2006; Gorton and Rouwenhorst, 2006; Kat and
Oomen, 2006). However, the onset of the GFC enticed a re-visitation
of the issue.
The financialization of commodity markets exacerbated the effects
of the crisis (Sadorsky, 2014; Christodoulakis, 2020; Nguyen et al.,
2020) due to the increasing synchronicity of financial markets and
the ensuing propagation of the distress to the financial system (López-
Espinosa et al., 2012). Such evolution in the architecture of the com-
modity markets is commonly recognized as the excess co-movement
between commodity and equity markets stemming from the growing
participation of financial investors in commodities (Ordu et al., 2018).
An immediate consequence of this rapid development is the urge for
punctual and efficient regulations that ensure the integrity of the
financial system and its stability under optimal conditions expressed
in the Commodity Exchange Act and issued by the European Security
Market Authority (ESMA).
In this context, the analysis of the mere risk exposure of the com-
modities (Giot and Laurent, 2003; Marimoutou et al., 2009; Aloui and
Mabrouk, 2010; González-Pedraz et al., 2014; Laporta et al., 2018) no
longer suffices to describe the features of the commodity markets due
to the accruing connections that have been developing (Diebold et al.,
2017; Balli et al., 2019). Furthermore, the wide extent of commodity
markets2 has drawn the attention of risk managers and regulators to
the assessment of commodity risk and the impact on the stability of
the financial system. As a matter of fact, ‘‘systemic risk matters to the
extent there is an impact on the broader economy’’ (Acharya et al.,
2012). A natural question is: to what extent does the financialization
of commodities contribute to triggering systemic crisis?
Over the last decade, academics and practitioners have delved into
investigating the nuances of commodity risks and the connections
between commodity markets and financial markets. Prokopczuk et al.
(2017) find that investors require compensation for bearing variance
risk in commodity markets, and a significantly negative realized premia
identify it. Moreover, commodity and equity variance swap payoffs
co-move with each other suggesting a connection between the two
segments of the market. Seeking to explain the dynamics of com-
modity prices, Fernandez-Perez et al. (2020) uncover the heightened
pricing ability of the commodity hazard fear relative to other well-
established stylized facts in the literature (Hirshleifer, 1988; Fernandez-
Perez et al., 2018; Gu et al., 2019). In particular, the portfolio strategy
in Fernandez-Perez et al. (2020) captures a premium that increases
during periods of market pessimism and it is linked to the evolution
of the VIX, commonly employed as a measure of investors’ sentiment
(Silvennoinen and Thorp, 2013; Gao and Süss, 2015). These studies
2 3
To date, the market size of the Commodity Dealing and Brokerage
Industry amounts to US $15 billions.
3
Energy Economics 117 (2023) 106446
attempt to quantify investors’ perception of risk in commodity markets
to provide a barometer of the broader financial stability.
Another prolific strand of the literature to which this paper adds
deploys spillover analysis to model the co-dependences of commodity
markets. Chief among them are the degree of interconnectedness with
assets traded in other markets (Büyükşahin and Robe, 2014; Reboredo,
2015; Mensi et al., 2017), the evolution of the connections between
commodity markets (De Nicola et al., 2016; Ji et al., 2018) and within
the same commodity sector (Sensoy, 2013; Shen et al., 2018), the
linkages between oil prices and other commodity markets such as
Precious Metals (Sari et al., 2010; Ewing and Malik, 2013), Agriculture
(Natanelov et al., 2011; Reboredo, 2012; Shahzad et al., 2018), and
Energy (Reboredo, 2015; Ferrer et al., 2018). The GFC also reveals as a
turning point in the literature on spillover analysis. For instance, Anton-
akakis and Kizys (2015) find that Gold, Silver, and Platinum play the
role of intense net transmitters in terms of volatility, whereas the re-
turns of Gold and Silver acquire this feature only before the GFC. Other
evidence of the nexus between the markets of Energy and Agriculture
is found in Al-Maadid et al. (2017). Within a VAR-GARCH framework,
they show that Energy and Agriculture exhibit tight connectedness,
increasing particularly after the four shock events: (i) 2006 food cri-
sis, (ii) the Brent oil bubble, (iii) the introduction of the Renewable
Fuel Standard policy, and (iv) the GFC. Combining the forecast error
variance decomposition and network theory, Balli et al. (2019) reveal
that total connectedness among commodities uncertainties increases
with the GFC. In particular, Precious Metals show safe-haven properties
presenting fewer spillovers with the other commodities even during the
crisis.
These works inspect the nature of commodities as financial assets
that can affect the stability of the financial system. However, recent
literature contends that the financialization is undergoing an enfeebling
phase of its cycle, addressed as de-financialization (Zhang et al., 2017).
This temporary phenomenon highlights even more the importance of a
further understanding of commodity markets and their interactions to
increase the awareness of financial investors during the financialization
reprise.
3. Methodology
In the following, we describe the procedure for estimating the time-
varying CoVaR (Section 3.1) and the theoretical foundations of the
stochastic ordering of the CoVaR (Section 3.2). The notation addresses
the commodity sector, 𝑘, for which we derive the results in both
the time-varying and sample analysis. The former provides the daily
monitoring of CoVaR, while the latter yields the stochastic ordering of
CoVaR using the distribution of the returns of the VIX, the commodities,
and the commodity sectors over the entire sample period.
3.1. Time-varying estimation of CoVaR
We employ the three-step procedure proposed by Girardi and Ergün
(2013) to provide daily estimates of the CoVaR for the portfolios
representing the commodity sectors.3
⧫ Step 1
Let 𝑅𝑘𝑡 denote the log-return of the commodity sector 𝑘 at day
𝑡, whereby 𝑡 = 1, … , 𝑇 and 𝑇 is the end of the sample period.
We assume that the ARMA(1,1) describes the conditional mean
of 𝑅𝑘𝑡 :
𝑅𝑘𝑡 = 𝜇𝑡𝑘 + 𝜀𝑘𝑡 , (3.1)
We remark that the procedure is applied to the log-returns of the
commodity sectors as well as to the log-returns of the single commodities.
G. Morelli Energy Economics 117 (2023) 106446

where 𝜇𝑡𝑘 = 𝛿0𝑘 + 𝛿1𝑘 𝑅𝑘𝑡−1 + 𝛿2𝑘 𝜀𝑘𝑡−1 , 𝛿0𝑘 is the intercept term, 𝛿1𝑘 and Let 𝑅𝑡 = (𝑅𝑠𝑡 , 𝑅𝑘𝑡 ) denote the bivariate vector modelled as:
𝛿2𝑘 are, respectively, the AR and MA coefficients, 𝜀𝑘𝑡 = 𝑧𝑡 𝜎𝑡𝑘 , 𝑧𝑡 is
drawn from the Normal ( ), Skewed-Normal ( ), Student’s-t 𝑅𝑡 = 𝜇𝑡 + 𝜀𝑡 , (3.3)
( ), Skewed-Student’s-t ( ), and Generalized Hyperbolic () where 𝜇𝑡 is the vector of the conditional mean of the returns and
to identify the models that better capture skewness and kurtosis 𝜀𝑡 is the vector of the residuals. We assume that the residuals are
in the data. We denote 𝛹 (⋅) ∈ { ,  ,  ,  , } the choice heteroskedastic:
of the conditional distribution and 𝛹 the set of the parameters. 1
The renowned presence of various types of ‘‘leverage effect’’ 𝜀𝑡 = 𝛴𝑡 2 𝑧𝑡 𝑧𝑡 |𝑡−1 ∼ 𝜓 𝑠,𝑘 , (3.4)
in commodity (Carnero and Pérez, 2019) and financial mar-
and the variance–covariance matrix is given by:
kets (Braun et al., 1995) prompts us to consider the exponential
GARCH model (E-GARCH) of Nelson (1991) and the GJR-GARCH 𝛴𝑡 = 𝐷𝑡 𝐶𝑡 𝐷𝑡 , (3.5)
model of Glosten et al. (1993) to express the dynamics of the
volatility 𝜎𝑡𝑘 .4 In the selection of the most appropriate models, we where 𝑡−1 is the information set up to 𝑡 − 1, 𝜓 𝑠,𝑘 is the bivariate
also include the standard GARCH (sGARCH) model as a bench- distribution with parameters contained in 𝜓 𝑠,𝑘 , 𝐷𝑡 is a diagonal
mark. Thus, we use the following specifications to estimate the matrix of the volatility, and 𝐶𝑡 is the correlation matrix:
volatility: [ 𝑠 ] [ ]
𝜎 0 1 𝜌𝑠,𝑘
𝐷𝑡𝑘 = 𝑡 𝑘 𝐶𝑡𝑘 = 𝑠,𝑘 𝑡 . (3.6)
0 𝜎𝑡 𝜌𝑡 1
∙ sGARCH: (𝜎𝑡𝑘 )2 = 𝜁0𝑘 + 𝜁1𝑘 (𝜀𝑘𝑡−1 )2 + 𝜁3𝑘 (𝜎𝑡−1
𝑘 )2
According to the specification chosen for the univariate model
∙ E-GARCH: log(𝜎𝑡𝑘 )2 = 𝜁0𝑘 + 𝜁1𝑘 (|𝑧𝑡−1 | − E(|𝑧𝑡−1 |)) + (sGARCH, E-GARCH, or GJR-GARCH), we compute the elements
𝑘 )2
𝜁2𝑘 𝑧𝑡−1 + 𝜁3𝑘 log(𝜎𝑡−1 on the diagonal of 𝐷𝑡𝑘 . Finally, the correlation matrix 𝐶𝑡𝑘 is
∙ GJR-GARCH: (𝜎𝑡𝑘 )2 = 𝜁0𝑘 + (𝜁1𝑘 + 𝜁2𝑘 I𝜀𝑘 𝑘 2
<0 )(𝜀𝑡−1 ) + governed by the process:
𝑡−1
𝑘 )2 ,
𝜁3𝑘 (𝜎𝑡−1 𝑄𝑘𝑡 = (1 − 𝜃1𝑘 − 𝜃2𝑘 ) 𝑄̄ 𝑘 + 𝜃1𝑘 𝜂𝑡−1
𝑘
𝜂𝑡−1𝑘′ + 𝜃2𝑘 𝑄𝑘𝑡−1
−1 𝑘 𝑘∗ −1
(3.7)
𝐶𝑡𝑘 = (𝑄𝑘∗
𝑡 ) 𝑄𝑡 (𝑄𝑡 ) ,
where 𝜁0𝑘 , 𝜁1𝑘 , 𝜁2𝑘 , 𝜁3𝑘 are the model parameters that account
where 𝜃1𝑘 and 𝜃2𝑘 are the DCC coefficients, 𝑄̄ 𝑘 is the unconditional
for, respectively: the long-run variance, the weight assigned to
correlation matrix, 𝑄𝑘∗𝑡 is a diagonal matrix containing the square
the lagged errors, the asymmetric response of the volatility to 𝑘 = (𝐷𝑘 )−1 𝜀𝑘 :
root of the elements of 𝑄𝑘𝑡 , and 𝜂𝑡−1 𝑡−1 𝑡−1
the shocks (when appraised), and the weight given to the past
√
variance. The restrictions required on the parameters to ensure ⎡ 𝑞 𝑠,𝑠 0 ⎤
weak stationarity and the positiveness of (𝜎𝑡𝑘 )2 are: 𝜁0𝑘 ≥ 0, 𝜁1𝑘 ≥ 0, 𝑄𝑘∗ ⎢ 𝑡
√ ⎥. (3.8)
𝑡 =⎢
𝜁𝑘 ⎣ 0 𝑞𝑡𝑘,𝑘 ⎥⎦
𝜁3𝑘 ≥ 0 and 𝜁1𝑘 +𝜁3𝑘 < 1 for the sGARCH and 𝜁3𝑘 ≥ 0, 𝜁1𝑘 + 22 +𝜁3𝑘 < 1,
besides those of the sGARCH on the individual parameters, for the 𝑞𝑡𝑠,𝑘
We obtain the elements of 𝐶𝑡𝑘 from 𝜌𝑠,𝑘
𝑡 = √ . This ensures
GJR-GARCH. The details on the rationale behind the selection of 𝑞𝑡𝑠,𝑠 𝑞𝑡𝑘,𝑘
the final models are reported and discussed in Sections 4, 4.1.1, that 𝐶𝑡𝑘 and 𝛴𝑡𝑘 are positive definite. Usual restrictions on the
and 4.2.1 of the Empirical Analysis. parameters estimated through Maximum Likelihood are 𝜃1𝑘 , 𝜃2𝑘 > 0
The estimation of the GARCH-type models in Step 1 is required and, if 𝜃1𝑘 + 𝜃2𝑘 < 1, the correlation process is mean reverting
to compute the VaR for the commodity sectors. Specifically, around 𝑄̄ 𝑘 .
the 𝑉 𝑎𝑅𝛼𝑘 is defined as the (1 − 𝛼)th quantile of the returns ⧫ Step 3
𝑡
distribution5 of sector 𝑘 at time 𝑡 (Duffie and Pan, 1997): We estimate the 𝐶𝑜𝑉 𝑎𝑅𝛼,𝛽 𝑠|𝑘𝑡
. To do this, we generate the pdf of
( )
𝑅𝑡 , 𝑓𝑡 (𝑟𝑠 , 𝑟𝑘 ), according to the distribution 𝛹 (⋅). Then, we solve
P 𝑅𝑘𝑡 ≥ VaR𝛼𝑘 = 𝛼. (3.2)
𝑡 analytically:
𝛼,𝛽
⧫ Step 2 𝐶𝑜𝑉 𝑎𝑅𝑠|𝑘 ∞
𝑡
We fit the Dynamic Conditional Correlation model (DCC) of Engle 𝑓𝑡 (𝑟𝑠 , 𝑟𝑘 ) 𝑑𝑟𝑠 𝑑𝑟𝑘 = 𝛼𝛽. (3.9)
∫−∞ ∫𝑉 𝑎𝑅𝛼
(2002) to capture the interdependences between the financial 𝑘𝑡

system, 𝑠, and the commodity sector 𝑘.6 We adapt classical backtesting procedures described in the Ap-
pendix to validate the CoVaR.

4
We thank one of the anonymous Referee for suggesting the use of non- 3.2. Stochastic ordering of CoVaR
linear GARCH models, thus refining the overall methodology to reflect more
precisely the features of the returns in commodity markets.
5
We adopt the loss distribution for the returns, thus negative values of the We delineate the theoretical foundations of the stochastic ordering
returns are gains while positive values represent losses. of CoVaR introduced in Mainik and Schaanning (2014), that we exploit
6
A primary justification for the use of DCC-GARCH is due to the fact that to build the stochastic ordering of systemic risk in commodity markets.
we build on the procedure originally proposed in Girardi and Ergün (2013), To this purpose, we refer to the distribution of the log-returns of
which we extend thriving from the suggestions in the previous questions and the financial system, the commodity, and the commodity sector over
thus fitting the DCC-EGARCH which accounts for the leverage effect detected the entire sample period. We briefly recall the notion of first order
in the commodities. Four other reasons support the use of DCC from the set
stochastic dominance (FOSD).
of multivariate GARCH (MGARCH) models (Bauwens et al., 2006). First, the
DCC directly estimates the time-varying correlation and portrays the typical
correlation clustering that may arise during market turmoils. Second, it does
not introduce restrictive assumptions on the (un)conditional correlation (as in GARCH in Van der Weide (2002)) in the second step of the procedure since
the Orthogonal GARCH in Alexander and Chibumba (1996)), causing notable it is a rarefied task of the CoVaR. Besides, we do not focus on the detection
underestimation of the magnitude of the connection between the financial of underlying components of the bivariate process 𝑅𝑡 . Fourth, the successful
system and the commodity sector. Third, we do not seek to capture the results in the original paper foster the DCC over other MGARCH models and
spillovers from one market to the other (as in the Generalized-Orthogonal encourage us to exploit it to ensure flexibility in estimating the parameters.

4
G. Morelli Energy Economics 117 (2023) 106446

( )
Definition
( ′ ) 1 (First Order Stochastic Dominance). Let 𝑅𝑠 , 𝑅𝑘 and of such asset class with broader financial markets drive commodity
′
𝑅𝑠 , 𝑅𝑘 be bivariate random vectors with marginal cumulative dis- price fluctuations, prompting the instalment of specific regulations to
( 𝑘) ( ) monitor the commodity risk.
tribution functions (cdfs) 𝐹𝑅𝑠 (𝑟𝑠 ) = 𝐹𝑅𝑠′ (𝑟
(
𝑠 ) and 𝐹
)𝑅𝑘 𝑟 = 𝐹𝑅𝑘′ 𝑟𝑘 .
( ) ′ ′ The Markets in Financial Instruments Directive (MiFID) and the
Then, 𝑅𝑠 , 𝑅𝑘 stochastically dominates 𝑅𝑠 , 𝑅𝑘 at the first order,
( 𝑠 𝑘 ) ( 𝑠′ 𝑘′ ) Dodd Frank Act introduced in 2007 and 2010, respectively, guaran-
i.e. 𝑅 , 𝑅 ⪰ 𝑅 , 𝑅 if: tee more efficient markets through the regulation of the most traded
( ′ ) financial contracts such as commodity derivatives and highlight the
( ) ′ ( )
P 𝑅𝑠 ≤ 𝑟𝑠 , 𝑅𝑘 ≤ 𝑟𝑘 ≤ P 𝑅𝑠 ≤ 𝑟𝑠 , 𝑅𝑘 ≤ 𝑟𝑘 , ∀ 𝑟𝑠 , 𝑟𝑘 ∈ R2 . importance of managing the effects of oil price volatility and the related
spillovers (Technical Committee of the International Organization of
(3.10) Securities Commissions, 2011) in the design of quantitative policies.
The following result allows us to provide a robust ranking of the In addition, to enhance transparency and deal with the inflationary
CoVaR, relying on the FOSD that holds between the log-returns of the pressure in agricultural commodity prices in the years 2010–2012,
commodities and the commodity sectors in our analysis. Therefore, MiFID was updated to MiFID II (European Parliament and the Council
higher contributions of the commodity risks on the systemic risk cor- of the European Union, 2018) by the ESMA.
respond to higher probability of the losses of jointly exceeding certain Two recent shock events have shed light on the need for robust
thresholds. and tailored regulatory frameworks for commodities: the Covid-19 pan-
demic and the Russian–Ukrainian conflict. The outbreak of Covid-19
( ) ( ′
Theorem 3.1 (Mainik and Schaanning, 2014). Let 𝑅𝑠 , 𝑅𝑘 and 𝑅𝑠 , in 2020 has propelled severe downturns and steep rises in commodity
′
) ( ) prices resulting from the combination of surplus in energy commodities
𝑅𝑘 be bivariate random vectors with joint cdfs 𝐹𝑅𝑠 ,𝑅𝑘 𝑟𝑠 , 𝑟𝑘 and (especially oil) and the increasing demand for commodities as restric-
( 𝑠 𝑘)
𝐹𝑅𝑠′ ,𝑅𝑘′ 𝑟 , 𝑟 respectively, and suppose 𝐹𝑅𝑠 (𝑟𝑠 ) = 𝐹𝑅𝑠′ (𝑟𝑠 ). Assuming tions on transportation eased. The beginning of the Russia–Ukrainian
( ) ( )
that 𝐹𝑅𝑠 (𝑟𝑠 ), 𝐹𝑅𝑘 𝑟𝑘 , 𝐹𝑅𝑠′ (𝑟𝑠 ) and 𝐹𝑅𝑘′ 𝑟𝑘 are continuous distributions, war on February 24, 2022 has exacerbated extant tensions in the global
( 𝑠 𝑘) ( ) ( )
if and only if 𝐹𝑅𝑠′ ,𝑅𝑘′ 𝑟 , 𝑟 ≥ 𝐹𝑅𝑠 ,𝑅𝑘 𝑟𝑠 , 𝑟𝑘 (that is, 𝑅𝑠 , 𝑅𝑘 ⪰ supply chain, causing surges in the prices of Wheat, Tin, Aluminium,
( ′ ′
)
𝑅𝑠 , 𝑅𝑘 ) then: Nickel, Natural Gas UK, Heating Oil, Crude Palm Oil, Rapeseed, Soy-
( ′ ) bean, Soybean Meal, and Soybean Oil (Figure 5 in the online Appendix
( ) ′
CoVaR𝛼,𝛽 𝑅𝑠 ∣ 𝑅𝑘 ≤ CoVaR𝛼,𝛽 𝑅𝑠 ∣ 𝑅𝑘 ∀ (𝛼, 𝛽) ∈ (0, 1) , (3.11) C). Russia is a renowned exporter of Wheat, Natural Gas, Nickel, Crude
( ) Oil, and Aluminium, while Ukraine mainly deals with the exportation
where CoVaR𝛼,𝛽 𝑅𝑠 ∣ 𝑅𝑘 is the VaR of the financial system over the sample of food commodities. The episode has turned into a shock in commodity
period given that the commodity sector 𝑘 has exceeded the VaR. markets as the number of export bans increased, leading to changes in
price forecasts. For instance, Energy prices are expected to rise by 51%
Proof. See Mainik and Schaanning (2014). □ compared to 3% in the pre-war period and prices of Precious Metals
commodities are expected to grow by 3% as opposed to the foreseen
4. Empirical analysis fall of 3% (World Bank Group, 2021). Such fluctuations in commodity
prices represent the main factor behind the increase in the cost of the
4.1. Data description European Emission Allowances (EUA). Higher gas prices encourage pro-
ducers to adopt CO2-intensive coal-fired power generation contributing
We collect daily time-series of futures prices of commodities mainly to the demand for carbon permits (European Central Bank, 2022).
traded on the Chicago Mercantile Exchange, the London Metal Ex- We discuss the descriptive statistics of the log-returns of the com-
change, and the New York Mercantile Exchange. After cleaning the modities to capture stylized facts and gauge the impact of the several
data for price dates of futures contracts in common, we remain with financial events that occurred during the sample period. Average log-
the sample of thirty-five commodities observed over the sample period returns are all close to 0 and EUA and Natural Gas are the only
spanning from October 3, 2005 to February 28, 2022 for a total of 4281
commodities with negative averages (Table 5 in the online Appendix
observations. These commodities belong to four different commodity
B). Energy commodities exhibit a higher degree of variability reported
sectors:
in the values of the standard deviation reaching the maximum in the
(A) Agriculture: Cocoa (CC), Coffee (CF), Corn (CO), Cotton (CT), sample for EUA. Natural Gas, Natural Gas UK, WTI, EUA, Coffee, and
Oat (OA), Orange Juice (OJ), Rough Rice (RR), Soybean (SB), Wheat show positively skewed distributions of the returns suggesting
Soybeans Meal (SM), Soybeans Oil (SO), Sugar (SU), Wheat (WH), the exposure to few remarkable gains as opposed to more frequent
Live Cattle (LE), White Sugar (SW), Rapeseed (XRQ), Canola (CA), moderate losses. The 𝑝-value of the Jarque–Bera test and the kurtosis
Rubber (JRU), and Crude Palm Oil (FCPO). signal the departure from normality of the returns. Correlations be-
(E) Energy: Gasoline (GA), Heating Oil (HO), Low Sulphur Gasolio tween the commodities range from 0 to 0.85 with the largest portion of
(LS), Natural Gas (NG), Natural Gas UK (NU), WTI Crude Oil the values below 0.4 (Figure 6 in the online Appendix C). In particular,
(WT), and EUA Emissions (EUA). the strongest relationships are found between Gold and Silver, White
(I) Industrial Metals: Aluminium (AL), Copper (CP), Lead (LD), Sugar and Sugar, WTI and Heating Oil, WTI and Gasoline, Soybean
Nickel (NI), Zinc (ZI), and Tin (TI). and Soybean Meal, Silver and Platinum, and Wheat and Corn. Tail
(P) Precious Metals: Gold (GD), Palladium (PA), Platinum (PL), and dependence coefficients (TDCs) endorse the results on the connections
Silver (SI). between commodities (Figure 7 in the online Appendix C). Specifi-
cally, upper TDCs tend to be higher than low TDCs, suggesting that
Before analysing the descriptive statistics of the commodities, we
commodities are more linked in terms of extreme losses rather than
delve into the discussion of relevant financial events for commodity
gains. When we jointly consider each single commodity with the VIX,
markets occurred during the sample period. Investments in commodi-
we notice that the TDCs are remarkably lower than the counterparts
ties gained popularity especially in response to the GFC in 2008 as
for the commodities. Thus, linkages between tail observations in the
market participants began to consider commodities as alternative as-
distribution of the returns are weaker in commodity-VIX relationships
sets to stocks. Moreover, innovations in the IT sector, population and
relative to inter-commodity relationships, probably due to the different
income growth have unleashed opportunities for international trade of
risk drivers that affect stock and commodity markets.
commodities increasing production and consumption. However, several
episodes have proved that endogenous and exogenous interactions ⧫ Detecting the Leverage Effect

5
G. Morelli Energy Economics 117 (2023) 106446

In the spirit of Carnero and Pérez (2019), we study the leverage Table 1
Summary of the results on the type of leverage effect detected for the commodities
effect in commodity markets using the sample cross-correlation be-
and the VIX. We distinguish among absence of leverage effect (None/Weak), negative
tween volatility and log-returns. Next, we test the significance of the relationship between returns and volatility (Direct), positive relationship between
cross-correlations through the robust methods introduced in Dalla et al. returns and volatility (Inverse), and the mixture of the previous two cases (Mixed). The
(2020), which account for heteroskedasticity, dependence, and mutual category is assigned considering the statistical significance of the cross-correlations and
dependence in the data. To proxy the behaviour of the underlying the sign of the values of the CCF at the corresponding lags. Sample period: October 3,
2005–February 28, 2022.
volatility for each commodity, we use the squared log-returns (Zivot, Type of global leverage effect
2009). None/Weak Direct Inverse Mixed
Figure 8 in the online Appendix C shows the cross-correlation CC∙ SB− CF− CO
function (CCF) based on the lagged log-returns and the squared log- XRQ∙ LE− CT OA
returns of each commodity. For negative lags, the CCF represents RR CA SW+ SM
the correlation between the volatility and the log-returns ‘‘Lag-days’’ SU FCPO WH∗
JRU HO− NU
before, whereas for positive lags, the CCF represents the correlation OJ LS− ZI
between the volatility and the log-returns ‘‘Lag-days’’ ahead. The tra- SO EUA− GD
ditional (direct) leverage effect is, thus, detected when the values NA CP VIX∗
of the CCF are negative. On the contrary, positive values signal the WTI PA−
GA SI−
inverse leverage effect. Generally, the ‘‘zero-Lag’’ cross-correlation is
AL PL−
negative and assumes the highest value in module relative to other lags, LD∙
portraying stronger negative relationship between returns and volatility TI
on the same day. The pattern of the CCF resembles sinusoidal trends in NI
many commodities, except for Soybean and Live Cattle, where the CCF CC∙ , XRQ∙ , LE∙ : Absence of significant leverage effect.
is primarily negative. The CCF for the VIX is increasing with respect SB− , LC− , HO− , LS− , EUA− , PA− , SI− , PL− : Several significant cross-correlations are
mostly found at negative lags.
to negative lags, indicating progressively stronger positive relationship
SW+ : Several significant cross-correlations are mostly found at positive lags.
between the returns of the VIX and the volatility (inverse leverage WH∗ , VIX∗ : Inverse leverage effect at negative lags - direct leverage effect at positive
effect). After the ‘‘zero-Lag’’, the CCF turns negative and decreases as lags.
the lag grows. This finding accentuates the discrepancy between the
response of commodity markets to new information and that of market
volatility. Overall, the sinusoidal trend for the commodities signals that
Appendix B, we notice that the commodities in Industrial Metals are
recurrent information affects the dynamics of the returns (volatility)
mostly featured by weak leverage effect and have associated highest
and, shortly after, of the volatility (returns). The monotonic trend of the
CCF of the VIX instead suggests that most recent information impacts BIC for the sGARCH specification (except for Zinc which shows mixed
the volatility and the returns. leverage effect). Similarly, for Natural Gas, Soybean Oil, Sugar, and
Table 1 combines the results gathered testing the significance of Cocoa, which exhibit weak leverage effect, the best model relies on the
the cross-correlations and the sign of the cross-correlations. We find sGARCH.
frequent and significant leverage effect for 21 commodities and dis-
tinguish such stylized fact into three categories: direct, inverse, and
mixed, which blends the first two effects. Direct leverage effect is more
frequent, especially at negative lags, suggesting that negative (positive) 4.1.1. Portfolio construction
returns generally trigger volatility increases (decreases) in Soybean,
We synthetize the behaviour of the commodity sectors Agriculture
Live Cattle, Heating Oil, Low Sulphur Gasolio, EUA, Palladium, Silver,
and Platinum. Differently, Coffee, Cotton, and White Sugar exhibit in- (A), Energy (E), Industrial Metals (I), and Precious Metals (P), building
verse leverage effect, which is more pronounced for White Sugar at the the corresponding ES minimizing portfolios (Rockafellar et al., 2000).
positive lags. In this case, as volatility accrues, returns tend to increase The ES is the expected loss of the portfolio under the condition that the
shortly after and vice-versa. These results endorse the heterogeneity 𝑉 𝑎𝑅𝛼𝑘 has been exceeded:
𝑡
that characterizes commodity markets and, in turn, commodity risks,
highlighting the structural differences between commodity markets and 1
𝐸𝑆 1−𝛼 (𝜔𝑘𝑡 ) = 𝑔(𝜔𝑘𝑡 , 𝑅𝑘𝑡 ) 𝑓 (𝑅𝑘𝑡 ) 𝑑𝑟𝑘 , (4.1)
the VIX. For the fear index, we strongly reject the null hypothesis of 𝛼 ∫𝑔(𝜔𝑘 ,𝑅𝑘 )≥𝑉 𝑎𝑅𝛼
𝑡 𝑡 𝑘𝑡
the test on the cumulative cross-correlations at every lag providing
significance to the results on the pattern of the CCF. where 𝑔(𝜔𝑘𝑡 , 𝑅𝑘𝑡 ) is a loss function of the positions 𝜔𝑘𝑡 on each com-
The notion of leverage effect is commonly associated with that of modity in sector 𝑘 on day 𝑡, 𝑓 (𝑅𝑘𝑡 ) is the distribution of the loss
asymmetric volatility. We assess the goodness of fit of typical GARCH- of the commodity sector. Here, the VaR is compared to 𝑔(𝜔𝑘𝑡 , 𝑅𝑘𝑡 )
type models to capture the leverage effect, fitting sGARCH, E-GARCH,
which depends on the vector of allocated capital and the returns. To
and GJR-GARCH models with the  ,  ,  ,  , and  distri-
butions. Then, we extract the Bayesian Information Criteria (BIC) to overcome the difficulty introduced by the presence of the VaR in the
identify the best trade-offs between model complexity and explain- extreme of the integral, the new convex function 𝐹 1−𝛼 (𝜔𝑘𝑡 , 𝑉 𝑎𝑅𝛼𝑘 ) =
𝑡
ability (Tables 7, 8, 9, and 10 in the online Appendix B). The BIC 𝑉 𝑎𝑅𝛼𝑘 + 𝐸𝑆 1−𝛼 (𝜔𝑘𝑡 ) characterizes and coincides with the ES when it is
𝑡
signals that the best GARCH-type models generally exploit the E- minimized. One possible way to approximate the integral in the ES is
GARCH specification with the  ,  , and  distributions. However, through the simulation of 𝐵 scenarios for the assets included in the
the related values of the BIC do not remarkably differ. We find that portfolio. We simulate the scenarios of the returns adopting the best
the leverage coefficient is significant for all the commodities in the E-
model identified for each commodity through the BIC (Tables 7, 8,
GARCH specification, while only for 14 commodities the GJR-GARCH
provides significant estimates. We believe that the higher goodness of 9, and 10 in the online Appendix B). Using the scenarios approach,
fit of the E-GARCH lies in the ability to capture asymmetric volatility 𝐹 1−𝛼 (𝜔𝑘𝑡 , 𝑉 𝑎𝑅𝛼𝑘 ) is approximated by 𝐹̃ 1−𝛼 (𝜔𝑘𝑡 , 𝑉 𝑎𝑅𝛼𝑘 ) as:
𝑡 𝑡
in response to both positive and negative shocks. In this manner,
𝐵 [ ]+
we describe the different types of leverage effect previously detected. 1 ∑
𝐹̃ 1−𝛼 (𝜔𝑘𝑡 , 𝑉 𝑎𝑅𝛼𝑘 ) = 𝑉 𝑎𝑅𝛼𝑘 + 𝑔(𝜔𝑘𝑡 , 𝑅𝑘,𝑏
𝑡 ) − 𝑉 𝑎𝑅𝛼𝑘 , (4.2)
Merging the results in Table 1 and Tables 7, 8, 9, and 10 in the online 𝑡 𝑡 𝛼𝐵 𝑏=1 𝑡

6
G. Morelli
Fig. 1. Minimized ES of the portfolios representing the commodity sectors Agriculture, Energy, Industrial Metals, and Precious Metals. Sample period: October 3, 2005–February
28, 2022.
where 𝑚+ = max(0, 𝑚). The minimization problem is therefore devel-
oped as:
1 ∑
𝐵
min 𝑉 𝑎𝑅𝛼𝑘 + 𝑢 age effect of the portfolio returns is emphasized at the most recent lags,
𝜔𝑘𝑡 ,𝑢𝑏 ,𝑉 𝑎𝑅𝛼𝑡 𝑡 𝛼𝐵 𝑏=1 𝑏
𝑘 suggesting that the optimization of the ES defuses the intensity of the
𝑠.𝑡. 𝜔𝑘𝑡 1𝑁 𝑘 = 1
(4.3)
𝜔𝑘𝑡 𝑅𝑘𝑡 ≥ 𝑟̄𝑡 𝑘
𝑢𝑏 ≥ 0
𝑢𝑏 ≥ 𝑔(𝜔𝑘𝑡 , 𝑅𝑘,𝑏 ) − 𝑉 𝑎𝑅𝛼𝑘 ,
𝑡 appropriate only in the case of Energy, probably due to the presence
[ ]+
where 𝑢𝑏 is an auxiliary variable that replaces 𝑔(𝜔𝑘𝑡 , 𝑅𝑘,𝑏 𝛼
𝑡 ) − 𝑉 𝑎𝑅𝑘
and 𝑔(𝜔𝑘𝑡 , 𝑅𝑘,𝑏 𝑘 𝑘,𝑏
𝑡 ) ∶= 𝜔𝑡 𝑅𝑡 . Solving the linear program in (4.3), we
obtain the portfolio returns of the four sectors.
Table 11 in the online Appendix B reports the descriptive statistics
of the portfolio returns shown in Figure 9 in the online Appendix
C. The average returns are all above 0.1% due to the target return
imposed in the optimization. Energy and Agriculture are the most and
less volatile sectors and yield the highest and the lowest average return,
respectively. The loss distribution of the portfolio returns is not largely
skewed and presents fat tails. However, such stylized fact is remark-
ably assuaged compared to the individual commodities within each
portfolio. Figure 9 in the online Appendix C reveals that Agriculture
is the sector showing greater resilience to the GFC and the Covid-19
crisis. The pattern of the log-returns of the VIX completely departs
from that of the portfolio returns of the commodity sectors, showing
higher magnitudes and pronounced volatility. Moreover, the frequent
spikes of the VIX suggest that commodity markets do not always
represent the drivers of the most volatile periods in the US equity
market. The positive correlations (Table 12 in the online Appendix
B) between the commodity sectors suggest moderate interconnection,
which is stronger between Industrial and Precious Metals. Besides, the
tail dependence coefficients show that interconnections amplify when
simultaneous extreme losses occur (Table 13 in the online Appendix B).
In particular, the losses in the Agricultural sector are more related to
the losses in the other sectors, pointing out likely channels of spillovers.
The optimization of the ES allows us to capture the contribution of
the commodity risk to the systemic risk that would be obtained if
investment strategies primarily focused on the mitigation of the market
risk. The minimized ES of the portfolios (Fig. 1) depicts Energy as the
sector that mainly contributes to the market risk. The low magnitudes
and the constant level of the ES in the Agricultural sector suggest that
superior stability is achieved from global investments in such sector,
if we do not account for the relationship with the financial system.
The other sectors exhibit more vulnerability, especially during the first
years of the sample period and in 2017 for Energy.
Energy Economics 117 (2023) 106446
The CCF for the commodity sectors (Figure 10 in the online Ap-
pendix C) shows significant direct leverage effect in Agriculture, En-
ergy, and Precious Metals. Differently from the commodities, the lever-
relationship between return and volatility from past observations. For
completeness, we also fit the three GARCH-type models on the portfolio
returns of the commodity sectors (Table 14 in the online Appendix
B). Under the BIC criteria, the E-GARCH specification is the most
of Heating Oil, Low Sulphur Gasolio, and EUA, which exhibit strong
𝑡 direct leverage effect. Regarding the distribution, we find that the 
distribution is preferred with the exception of Precious Metals. As for
the commodities, the choice of the distribution succeeds to capture part
of the asymmetry in the volatility, providing higher goodness of fit for
the sGARCH model.
4.2. Time-varying estimation of CoVaR
We estimate the CoVaR to quantify and monitor the contribution
of sectorial commodity risks to the systemic risk.7 Since unpleasant
financial episodes have proved to affect the stability of commodity
markets through both price declines (downside risk) and upsurges
(upside risk), we compute two versions of the CoVaR that, based on
the conditioning event, capture the effects of these two scenarios of
financial distress. Therefore, we have the following computations of
CoVaR:
( )
P 𝑅𝑉𝑡 𝐼𝑋 ≤ CoVaR0.05,0.05 ∣ 𝑅𝑘𝑡 ≥ VaR0.05 = 0.05
𝑉 𝐼𝑋|𝑘𝑡 𝑘𝑡
( ) (4.4)
P 𝑅𝑉𝑡 𝐼𝑋 ≤ CoVaR0.95,0.05
𝑉 𝐼𝑋|𝑘
∣ 𝑅𝑘𝑡 < VaR0.95
𝑘
= 0.05.
𝑡 𝑡
Moreover, since one of the primary features of commodity markets
is the high heterogeneity in terms of drivers of commodity risks, we de-
velop the time-varying analysis also for four selected commodities, one
for each commodity sector. Considering the most traded commodities
according to the Futures Industry Association and those more affected
by the latest macroeconomic shocks, we choose Wheat, Natural Gas,
Aluminium, and Gold.
7
In the Appendix A, we provide robustness checks for both the time-varying
and the sample analysis as suggested by one of the Referees.
7
G. Morelli
4.2.1. Step 1: GARCH
In Step 1 of the procedure, we fit the GARCH-type models on the
log-returns of the commodity sectors and commodities to compute the
volatility. To estimate the VaR, we update the parameters of the model
using a rolling window of ℎ = 500 days and yield the one-day forecast
of the VaR from the volatility. For the purpose of the application,
we rely on the same model specification for all the commodities and
commodity sectors. This choice allows us to compare the risk measures
that are obtained from models with the same ability to accommodate
the features of the data. After combining the results on the goodness
of fit in Tables 7, 8, 9, 10, 14, and 15 in the online Appendix B, we fit
E-GARCH- models.
The volatility of the portfolio returns of the commodity sectors
(Fig. 2) increase during the aftermath of the GFC, showing the first sign
of recovery from the shock only in mid-2009. Afterwards, Industrial
and Precious Metals commodities encounter market turmoil during the
years 2011–2012, probably due to the aviation crisis (The European
Cockpit Association, 2012). Financial distress is also widely amplified
for Energy from 2014 to 2017, propagating uncertainty to the Industrial
and Precious Metals sectors. Such persistent and rapid surge of Energy
volatility can be attributed to the growing interest in renewable tech-
nologies in the Energy sector and the efforts of developing countries to
(i) meet the new standards and (ii) comply with climate issues, which
represent the most critical source of uncertainty in carbon prices (World
Energy Council, 2015). In response to the Covid-19 crisis in 2020,
Energy commodity prices are newly affected by severe fluctuations,
which cause subsequent spillovers in the volatility of Precious Metals
commodities. The Agricultural sector is the most resilient maintaining
the lowest magnitudes during almost the entire sample period. The
volatility of the returns of the four commodities are generally higher
than the corresponding counterparts for the commodity sectors, high-
lighting the diversification effect of the ES optimization. The exception
is Gold which appears less volatile than the related sector. Thus,
Palladium, Silver, and Platinum are major triggers for uncertainty in
Precious Metals. The vulnerability of the prices of Natural Gas to
macroeconomic shocks is emphasized, especially during the months
before the outbreak of the Russian–Ukrainian conflict, where we ob-
serve rising volatility, successfully assuaged by the ES optimization.
Comparing the volatility of the VIX to those of the commodities and
sectors, we notice that: (i) the estimates of the volatility of the VIX are
higher than the commodity counterparts and (ii) upwards movements
of the volatility of the VIX do not always correspond to accrued
severe fluctuations in commodity prices. Intuitively, these two features
jointly suggest that the VIX reflects market expectations to a broader
extent and commodity markets are a shard in this portrayal of market
uncertainty. The contribution of the sectors, the commodities, and the
VIX to the market risk as measured by the VaR support these results.8
The computation of the CoVaR allows us to assess and monitor the
discrepancy with the VaR establishing the sectors and the commodities
that have generally contributed more to the systemic risk during the
sample period.
4.2.2. Step 2: Bivariate DCC
We fit DCC-EGARCH(1,1) with bivariate Student’s-t distribution on
the log-returns of the commodity sectors and commodities, each paired
with the VIX. In this step of the procedure, we estimate the correla-
tions between the commodity sectors, the commodities, and the VIX
(Fig. 3) and retrieve the parameters to generate the pdf of the bivariate
Student’s-t necessary in Step 3. Overall, correlations show a mean-
reverting behaviour around zero, eminent co-movement, and increasing
8
We compute the VaR under the Student’s-t model as follows: 𝜇𝑡𝑘 +
√ the CoVaR, we rely on the conditional Hit sequence that monitors
𝜈𝑡𝑘 −2 𝑘
𝑣𝑘𝑡 𝜈𝑘
𝜎𝑡 , where 𝜈𝑡𝑘 is the degree of freedom of the Student’s-t distribution
𝑡
at time 𝑡 and 𝑣𝑘𝑡 ;1−𝛼 is the 1 − 𝛼 quantile of the distribution.
8
Energy Economics 117 (2023) 106446
roughness during periods of financial distress. The magnitudes of the
correlations are higher during the GFC for the commodity sectors,
Natural Gas, Aluminium, and Gold, suggesting that instability in the
US equity market is related to bull commodity markets. As for the
volatility, the correlation between Energy and the VIX is more volatile
from 2015 to 2017. Differently from the GFC, the outbreak of Covid
does not trigger remarkable fluctuations in the correlations, which tend
to progressively decrease. These facts suggest that commodity markets
are heterogeneous in terms of idiosyncratic risk drivers and responses
to unpleasant financial events. The sensitivity to market turmoils is the
main difference in correlations between the commodity sectors and the
VIX and counterparts for the four selected commodities. For instance,
the relationship between Wheat and the VIX is relatively weak and
not severely swayed by crisis events, while correlations for Natural
Gas surge in 2011 and for Gold in 2015–2017. Portfolio optimization
successfully smooths the effects of these episodes in the correlations for
the related sectors.
To assess the overall degree of connectedness within commodity
markets, we also fit the DCC-EGARCH(1,1) on the log-returns of the
four commodity sectors and monitor the correlations (Figure 11 in the
online Appendix C). Differently from the relationship with the VIX,
correlations between commodities are positive, range in [0; 0.6], and do
not show a mean-reverting behaviour during the sample period. Con-
trariwise, the estimates exhibit a sinusoidal slightly decreasing trend
between Industrial and Precious Metals. Concerning relevant financial
events, we notice that correlations increase in response to the GFC and
abruptly rise at the outbreak of Covid-19.
4.2.3. Step 3: CoVaR
We estimate the daily 𝐶𝑜𝑉 𝑎𝑅𝛼,𝛽 for the commodity sectors and
the four selected commodities. In Fig. 4, we report the 𝛥𝐶𝑜𝑉 𝑎𝑅𝛼,𝛽
𝑠|𝑘
=
𝑡
𝐶𝑜𝑉 𝑎𝑅𝛼,𝛽
𝑠|𝑘𝑡
− 𝑉 𝑎𝑅𝛼𝑘 , so that we can immediately gauge the conta-
𝑡
gion effect of the financial distress of the commodity sectors and
the commodities on the stability of the financial system. Estimates
of the 𝛥CoVaR across the commodity sectors show less variability
compared to those for the commodities. We observe remarkable co-
movement with Energy and Precious Metals slightly departing from
the other sectors in the years 2015–2017 and 2020–2022, respectively.
The contagion effects from commodity markets to the financial system
are stronger during the years 2017–2019, when the 𝛥CoVaR rapidly
increases. In Tables 20 and 21 in the online Appendix B, we summarize
specific results on the times the CoVaR does not exceed the VaR.
We remind that such events signal the weakening impact of market
risk in commodity markets on the systemic risk. As such, investors
should seek assets with this feature to build systemically safe-haven
portfolios. Generally, the VaR exceeds CoVaR more frequently in the
𝐶𝑜𝑉 𝑎𝑅0.05,0.05 series suggesting that the financial system is more prone
to encounter decreased contribution to the systemic risk when the
conditional distress stems from declines in commodity prices. However,
negative values of the distance between VaR and CoVaR do not sup-
port a remarkable discrimination between the impact of either fall or
rises in commodity prices on the systemic risk. Negative CoVaR–VaR
exceedances are stronger for Energy in the 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 and Precious
Metals in the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 . Regarding the commodities, the negative
distance between CoVaR and VaR is less amplified compared to the
commodity sectors. Therefore, portfolio optimization also contributes
to induce periods of increased mitigation of systemic risk.
4.2.4. Backtesting results
Table 2 reports the results of the backtesting procedures applied
to the CoVaR for the commodity sectors and the four selected com-
modities. We show the CoVaR exceedances for the commodity sectors
in the panels of Figure 12 in the online Appendix C. To backtest
the exceedances of the CoVaR when the VaR is exceeded. We reject
the null hypothesis of the Unconditional Coverage (UC) test for both
G. Morelli Energy Economics 117 (2023) 106446

Fig. 2. Annualized volatility of the commodity sectors Agriculture (A), Energy (E), Industrial Metals (I), and Precious Metals (P) (left panel), the commodities Wheat (WH), Natural
Gas (NA), Aluminium (AL), and Gold (GD) (right panel), and the VIX (panel at the bottom. Estimation period: September 5, 2007–February 28, 2022.

Fig. 3. Estimates of the correlations between the commodity sectors Agriculture (A), Energy (E), Industrial Metals (I), and Precious Metals (P) and the VIX (first panel) and
between the commodities Wheat (WH), Natural Gas (NA), Aluminium (AL), and Gold (GD) and the VIX (second panel) obtained fitting the DCC-EGARCH(1,1) on the log-returns.
Estimation period: September 5, 2007–February 28, 2022.

9
G. Morelli Energy Economics 117 (2023) 106446

Fig. 4. Estimates of the 𝛥CoVaR for the commodity sectors Agriculture (A), Energy (E), Industrial Metals (I), and Precious Metals (P) (first two panels) and the commodities Wheat
(WH), Natural Gas (NA), Aluminium (AL), and Gold (GD). Estimation period: September 5, 2007–February 28, 2022.

foundations of the stochastic ordering of CoVaR since Theorem 3.1 only

Table 2
Backtesting results of the CoVaR for the commodity sectors Agriculture (A), Energy (E), requires 𝐹𝑅𝑠 (𝑟𝑠 ) = 𝐹𝑅𝑠′ (𝑟𝑠 ) and the continuity in the distribution of the
Industrial Metals (I), and Precious Metals (P), and the four selected commodities Wheat commodity and the VIX to ensure the FOSD. Therefore, we choose one
(WH), Natural Gas (NA), Aluminium (AL), and Gold (GD). We report the p-values for single family distribution among those considered to foster the interpre-
the Unconditional Coverage (UC), Conditional Coverage (CC) tests, and the Actual over tation of the results and harmonize the ability of the model to capture
Expected Exceedances (AE) ratio. Estimation period: September 5, 2007–March 1, 2022..
𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 stylized facts within the sample of commodities. As for the time-
𝑠|𝑘
𝑡 𝑡𝑠|𝑘
UC CC AE UC CC AE varying estimation, we provide robustness checks for the methodology
A 0.0018 0.0083 0.1290 0.0064 0.0262 0.1550 employed throughout the investigation in the Appendix A.9
E 0.0366 0.1398 0.4166 0.0115 0.0465 0.2564
I 0.0008 0.0042 0.1176 0.0430 0.1445 0.3200 4.3.1. Stochastic ordering: Commodities
P 0.0000 0.0000 0.0000 0.0001 0.0010 0.0995
WH 0.0005 0.0024 0.1117 0.0003 0.0016 0.1047
Before we build the stochastic orderings, we deal with the choice
NA 0.0184 0.0527 0.3791 0.0042 0.0189 0.2234 of the distribution for the bivariate random vector of the VIX and
AL 0.0185 0.0000 0.3351 0.0386 0.1389 0.3750 the commodity fitting the  ,  , and  on the log-returns. To this
GD 0.0003 0.0000 0.0010 0.0056 0.0010 0.2409 purpose, we first estimate the models on the commodity individually
and compare the goodness of fit under the BIC (Table 16 in the online
Appendix B). The  and  distributions are largely preferred in the
sample, while the  distribution is the best choice for only four
commodities. When we consider the joint distribution of the commodity
and the VIX (Table 17 in the online Appendix B), the  and 
the sectors and the commodities, indicating that the proportion of distributions are the most frequent selection. However, the difference
CoVaR exceedances conditional on the scenario of financial distress between the values of the BIC for the three distributions is not highly
does not correspond to the proportion expected, set at 0.05. Regarding pronounced. We choose the  distribution as the final model to
the Conditional Coverage (CC) test, we accept the null hypothesis for
compute the CoVaR.10
𝐶𝑜𝑉 𝑎𝑅0.95,0.05 for Energy, Natural Gas and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 for Industrial
Table 3 reports the stochastic orderings of CoVaR for the commodi-
Metals and Aluminium. Therefore, the conditional CoVaR exceedances
ties. Both 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 exceed the VaR of the VIX,
for the other sectors and commodities tend to cluster. The values for
showing that commodity risks that arise from relevant gains and severe
the Actual over Expected Exceedances Ratios (AEs) suggest that CoVaR
losses harm the stability of the financial system (the US equity market).
exceedances are remarkably lower than expected. In particular, they
The only exception regards the losses of Crude Palm Oil which defuse
are reduced in the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 for all the sectors except Energy and
the degree of financial distress of the market. Notably, the magni-
for Gold and Aluminium. Backtesting results show that CoVaR, being
tudes of the 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 tend to be higher than the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05
greater than VaR for most of the sample period, provides more robust
counterparts. Therefore, the financial system is more vulnerable to
benchmarks for capital requirements built upon the degree of stability
losses in commodity returns mainly caused by reduced demand for the
of the financial system. These findings also confirm that commodity
commodities that exhibit this feature. Comparing the two rankings,
risks are not decoupled from uncertainty in equity markets.

4.3. Stochastic ordering 9

We lay out the results on the stochastic ordering of CoVaR for
the log-returns of the commodities over the entire sample period. To
accommodate for idiosyncratic stylized facts of the commodities (or
commodity sectors), we should adopt the best bivariate model for each
commodity and the VIX. This practice does not harm the theoretical
We thank one of the anonymous Referees for suggesting the inclusion of
the discussion of the robustness checks to validate the estimation procedure
of the CoVaR.
10
We thank the anonymous Referees for suggesting to refine the methodol-
ogy capturing the stylized facts of the commodities. In the Appendix A, we
discuss the underestimation of the systemic risk experienced assuming the
Gaussian distribution.

10
G. Morelli Energy Economics 117 (2023) 106446

we find moderate heterogeneity with some commodities that act as

Table 3
strong landmarks maintaining similar positions, such as EUA, WTI, Stochastic ordering of CoVaR exploiting the Generalized Hyperbolic distribution for
Rubber, Live Cattle, Soybean Meal, Heating Oil, Lead, Orange Juice, the commodities in the sample. We compute the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05
White Sugar, and Gold. Conversely, Crude Palm Oil, Rapeseed, and Tin which condition on the gains and losses exceeding the related VaR, respectively. In
encounter dire changes in the ranking positions suggesting asymmetric each column we report the absolute value of the CoVaR. Sample period: October 3,
2005–February 28, 2022.
effects of the contribution of the commodity risks to the systemic risk. CoVaR — Commodity, VaR0.95 = 0.1268
𝑉 𝐼𝑋
The essential roles these commodities play within the global supply 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05
chain and the asymmetric systemic perceptions in the market prompt Natural Gas UK 0.2916 EUA Emissions 0.3377
further investigation of the behaviour. For instance, price rallies of EUA Emissions 0.2791 Rapeseed 0.2761
the most used food oil in the world, Crude Palm Oil, threaten food WTI 0.2420 WTI 0.2529
Crude Palm Oil 0.2357 Gasoline 0.2528
accessibility for the poorest countries and reduce consumption in those
Nickel 0.2352 Rubber 0.2499
more developed. The inadvertent rise of Crude Palm Oil prices starts Rubber 0.2344 Natural Gas UK 0.2437
in 2019 also exacerbated by the harsh climate conditions in 2021 for Zinc 0.2280 Live Cattle 0.2411
the harvest of Rapeseed and Canola, widely used to derive vegetable Live Cattle 0.2253 Tin 0.2397
oils. These events led to the introduction of export bans spreading Natural Gas 0.2245 Canola 0.2369
Soybean Meal 0.2227 Zinc 0.2363
fear over commodity markets. Price drops in Rapeseed have stemmed
Rough Rice 0.2209 Soybean Meal 0.2357
from severe climate conditions, which have instilled major concerns Gasoline 0.2202 Nickel 0.2281
for the stability of the financial system. Similarly, the fall of Tin Canola 0.2195 Palladium 0.2270
prices, especially during Covid-19, has warned investors of imminent Rapeseed 0.2186 Silver 0.2243
Aluminium 0.2117 Platinum 0.2220
global recession, being China the largest producer and consumer of
Heating Oil 0.2116 Oats 0.2216
Tin. We believe that such asymmetries in macroeconomic shocks have Lead 0.2115 Lead 0.2212
exacerbated extant conditions of distress in the financial market, as Soybean Oil 0.2107 Soybean 0.2212
captured by the higher CoVaR for one of the two rankings. Corn 0.2089 Heating Oil 0.2182
Major threats to the stability of the financial system are WTI and Oats 0.2087 Rough Rice 0.2169
Palladium 0.2068 Corn 0.2150
EUA, which appear at the first three ranking positions in both the
Silver 0.2064 Low Sulphur Gasolio 0.2142
stochastic orderings of CoVaR. Introduced in 2005, EUAs are traded Soybean 0.2043 Natural Gas 0.2137
on the EU’s Emissions Trading System and are considered financial Wheat 0.2023 Cotton 0.2016
instruments with MiFID II. EUA prices have sharply increased since Sugar 0.2000 Aluminium 0.2016
2018 as more stringent climate change policies have been introduced Coffee 0.1985 Cocoa 0.2001
Low Sulphur Gasolio 0.1967 Copper 0.1987
in the EU to mitigate the climate risk and limit the long-term effects White Sugar 0.1962 Orange Juice 0.1972
on financial stability. Moreover, cold weather at the onset of 2021 Platinum 0.1960 White Sugar 0.1968
called for increasing demand for EUA certificates contributing to higher Orange Juice 0.1937 Soybean Oil 0.1967
prices. Besides energy policies, the other two crucial drivers of EUA Gold 0.1897 Coffee 0.1910
Cocoa 0.1895 Gold 0.1871
prices are the expected economic conditions and fuel switching (Koch
Cotton 0.1891 Wheat 0.1867
et al., 2014). In particular, the growth of wind and solar electricity Tin 0.1601 Sugar 0.1842
production triggers EUA price drops. The heterogeneity of the drivers of Copper 0.1593 Crude Palm Oil 0.0949
EUA price fluctuations and the systemic influence corroborate the high
estimates of the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 . Regarding WTI, the
relatively high liquidity and transparency establish contracts on Crude
Oil as international pricing benchmarks, entailing the contribution of
both price rises and drops to systemic uncertainty. Compared to the
first positions in the stochastic orderings, the lowest positions in the in the intermediate range [0.19; 0.22] obtained for the commodities
rankings show more variability. However, the presence of Gold in the as a result of the portfolio optimization, which seeks to balance the
last positions of both rankings suggests that the financial system is less contribution of groups of commodities with relatively high and low
sensitive to a broader range of distress scenarios for this commodity. CoVaR. Such groups also increase the similarity between the values of
Table 22 in the online Appendix B shows the stochastic ordering of the CoVaR coherently with the time-varying CoVaR in Fig. 4. The sec-
CoVaR for the commodities as of March 6, 2020. The contributions to ond effect of portfolio optimization is the reduced discrepancy between
the systemic risk after the divider date are generally higher, suggesting 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 .
a stronger systemic influence coming from both the upside and down- Interestingly, despite the lower variability of the estimates of the Co-
side risks of the commodities. Besides, heterogeneity in the estimates VaR for the commodity sectors, the stochastic orderings of
of the CoVaR after the Covid-19 crisis have grown, highlighting the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 eminently differ. We believe the main
need of more tailored polices that manage different degrees of systemic reason for this lies in the optimization problem. The two principal
risk in commodity markets in response to macroeconomic shocks. The elements that interfere are the allocation weights and the number of
severe contribution of EUA to the systemic risk was already established commodities included in the portfolio. For instance, Aluminium and
before the Covid-19 crisis, as well as the contributions of the upside Copper are the commodities with higher allocation weights, around
risk of Natural Gas UK and the downside risk of Rapeseed. We observe 20% of total investments. These weights minimize the losses of In-
the most relevant sensitivity to the Covid shock and its subsequent dustrial Metals that exceed the VaR. As a result of the decreased
effects from WTI, Natural Gas UK, and Gasoline. On the contrary, Gold magnitude of severe losses, the 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 for Industrial Metals is
confirms as safe-haven compared to the other commodities lowering the lowest. The higher weights in Precious Metals allocate, on average,
the ranking positions and reducing the CoVaR. 40% of capital to Gold. However, the meagre number of commodities
available in this sector does not allow to deaden the influence of the
4.3.2. Stochastic ordering: Commodity sectors other two commodities. Moreover, portfolio optimization focuses on
Table 4 reports the estimates of the two CoVaR for the commodity single commodities without accounting for the relationship with the
sectors. As for the commodities, the estimates of the CoVaR are higher VIX. Therefore, if not negligible weights are assigned to commodities
than the VaR of the VIX, indicating that systemic risk cannot be mit- with high 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 , then the CoVaR for the portfolio increases.
igated in the commodity sectors. The magnitude of the CoVaR hovers The values of CoVaR acquire even more relevance when considered

11
G. Morelli
Table 4
Stochastic ordering of CoVaR exploiting the Generalized Hyperbolic
distribution for the commodity sectors Agriculture (A), Energy (E),
Industrial Metals (I), and Precious Metals (P). We compute the
𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 which condition on the gains and losses
exceeding the related VaR, respectively. In each column we report the
absolute value of the CoVaR. Sample period: October 3, 2005–February
28, 2022.
CoVaR — Commodity Sectors, VaR0.95 𝑉 𝐼𝑋
= 0.1268
𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05
E 0.2193 P 0.2169
I 0.2054 A 0.2160
P 0.2032 E 0.2119
A 0.1994 I 0.2093
along with the correlations between the sectors. Hence, market turmoils
in Precious Metals may trigger more serious stress scenarios in the
financial system due to the likely additional distress of Industrial
Metals. Table 23 in the online Appendix B shows the stochastic ordering
of CoVaR for the commodity sectors as of March 6, 2020. Similarly to
the commodities, the magnitudes of the CoVaR are generally higher
than the counterparts in the pre-Covid period. In particular, we notice
the remarkable mitigation effects of the portfolio optimization on the
contribution of the downside risk of Energy to the systemic risk. Despite
the high systemic impact of WTI, Natural Gas UK, and Gasoline, the
Energy sector reaches only the third position in the ranking.
5. Conclusions & policy implications
This paper delineates a novel approach to measure the impact
of commodity risks on the stability of the financial system through
the stochastic ordering of CoVaR. The stochastic property of concor-
dance ordering of CoVaR ensures the statistically robust comparison of
the systemic risk in commodity markets. Our design provides policy-
makers, regulators, and risk managers with an instrument that pol-
ishes the awareness of the risks, beared by positions taken for each
commodity and the impact on the systemic risk.
The first part of the analysis discusses the behaviour of the volatility,
VaR, correlations, and CoVaR for the four commodity sectors (Agricul-
ture, Energy, Industrial Metals, and Precious Metals) and four selected
frequently traded commodities (Wheat, Natural Gas, Aluminium, and
Gold). To gauge different facets of commodity risks, we compute the
time-varying CoVaR conditioning on scenarios of distress that account
for falls and rises in commodity prices. In the second part, we build the
stochastic orderings of CoVaR for the commodities and the commodity
sectors. We observe that the estimates of the CoVaR are greater than the
VaR of the VIX, endorsing the role of the financialization of commodity
markets. In particular, surges in Energy prices amplify the instability
of the financial system, especially during the GFC and commodity
risks arising from Precious Metals exacerbate systemic financial distress
during Covid-19. Backtesting procedures applied to the CoVaR validate
the employment of such risk measure to build capital requirements
based on the degree of distress of the financial system. The stochastic
orderings of the CoVaR show that falls in commodity prices generally
trigger more severe systemic financial distress, and WTI and EUA are
the principal menaces to the stability of the financial system. WTI,
Natural Gas UK, and Gasoline have been the most affected by the Covid-
19 crisis, while EUA was established as a systemic menace also before
the outbreak of Covid-19.
One of the main challenges that acquires more relevance is then
the design of the right policy taking into account the manifold ef-
fects of commodity risks. Recently, ESMA has made some proposals
on commodity derivatives arguing exemptions from positions limits
12
Energy Economics 117 (2023) 106446
on risk-reducing positions (European Securities and Markets Author-
ity, 2021b). Several insights to this purpose can be retrieved from
our analysis. First, tackling the issue exposed by the ESMA, in the
spirit of Acharya et al. (2010) and Brownlees and Engle (2017), we
suggest regulators and policy-makers to include a penalty in margin
requirements for commodities during ordinary times reflecting the con-
tribution of the commodities and the commodity sectors to the systemic
risk. During periods of market turmoils, more attention should be paid
to those commodities that, especially in ordinary times, have demon-
strated to contribute to the instability of the financial system. Particular
regard is required for EUA. Despite the daily position reporting, deriva-
tives on EUA are not considered in the class of commodity derivatives.
Therefore, they are not regulated under the MiFID II and are not
subject to position limits and position management controls (European
Securities and Markets Authority, 2021a). Our study reveals that EUA
is a major contributor to the systemic risk, highlighting concerns for
the absence of the commodity in the regulation of commodity deriva-
tives. Second, to promote financial stability, incentives could be given
for positions taken on low-systemic risk impact commodities. Third,
according to the origin of the distress, restrictions and even bans can be
considered for high-systemic risk impact commodities. For instance, if
the stress concerns some risk factor that implicitly triggers the financial
distress of WTI Crude Oil, restrictions may be more loose compared to
the scenario where the distress arises from WTI Crude Oil itself or from
the Energy market in the first place.
One possible extension of this work generalizes the underlying
model to compute CoVaR, exploiting mixtures of elliptical distributions
that better capture stylized facts of asset returns. In addition, the
challenge of defining the CoVaR on a multiple-stress scenario that
considers a bucket of commodities simultaneously under stress should
be tackled. In this way, regulators and policy-makers are provided with
the ranking of the contributions of commodity risks to the systemic
risk capable of identifying the clusters of commodities that are more
likely to destabilize the financial system. Moreover, it could be relevant
to investigate whether the Conditional Autoregressive Value at Risk
by Regression Quantiles (Engle and Manganelli, 2004) as the CoVaR
yields different results in the assessment of systemic risk. However, this
approach would require the challenge of extending the results in Mainik
and Schaanning (2014) to time series analysis.
CRediT authorship contribution statement
Giacomo Morelli: Conceptualization, Writing – review & editing.
Appendix A. Robustness checks
We investigate the stochastic ordering of systemic risk in commodity
markets building a statistically robust ranking of the CoVaR defined
as in Girardi and Ergün (2013). In our assessment, we estimate both
the time-varying and sample CoVaR. For the former, we carry out the
estimation through the GARCH type models following the three-step
procedure of Girardi and Ergün (2013), whereas for the latter, we
rely on the joint density function generated according to the chosen
stochastic model. To accommodate for stylized facts of asset returns, we
exploit E-GARCH models combined with the Student’s-t distribution.
When we abandon the time-varying approach, we compute the CoVaR
referring to the distribution of the log-returns over the entire sample
period. Specifically, we choose the Generalized Hyperbolic distribution.
In this Appendix, we compare our results with those obtained in
the Gaussian benchmark framework that does not account for the
stylized facts. Moreover, we perform robustness checks studying the
discrepancy between the Gaussian estimates of the CoVaR and the
CoVaR as initially defined in Adrian and Brunnermeier (2011). The
major differences in the computation of the two definitions of CoVaR
reside in (i) the conditional event (𝑅𝑘𝑡 ≥ 𝑉 𝑎𝑅𝛼𝑘 vs 𝑅𝑘𝑡 = 𝑉 𝑎𝑅𝛼𝑘 ) and (ii)
𝑡 𝑡
the estimation approach (GARCH models vs quantile regression). We
G. Morelli Energy Economics 117 (2023) 106446

Fig. A.1. Estimates of the upside risk CoVaR for the commodity sectors Agriculture (A), Energy (E), Industrial Metals (I), and Precious Metals (P). We report the CoVaR obtained
fitting DCC-EGARCH assuming the Student’s-t distribution, the CoVaR obtained fitting DCC-GARCH assuming the Gaussian distribution, and the Gaussian 𝐶𝑜𝑉 𝑎𝑅=;0.95,0.05
𝑡 (the values
are denoted by the dots in each panel). Estimation period: September 5, 2007–February 28, 2022.

Fig. A.2. Estimates of the downside risk CoVaR for the commodity sectors Agriculture (A), Energy (E), Industrial Metals (I), and Precious Metals (P). We report the CoVaR obtained
fitting DCC-EGARCH assuming the Student’s-t distribution, the CoVaR obtained fitting DCC-GARCH assuming the Gaussian distribution, and the Gaussian 𝐶𝑜𝑉 𝑎𝑅=;0.05,0.05
𝑡 (the values
are denoted by the dots in each panel). Estimation period: September 5, 2007–February 28, 2022.

remark that conditioning on the restricting stress scenario 𝑅𝑘𝑡 = 𝑉 𝑎𝑅𝛼𝑘
𝑡
does not portray a realistic picture of the systemic contribution of
commodity risks during financial distress. Besides, such conditioning
event never occurs in stochastic models with continuous density func-
tions. Along with this line, Mainik and Schaanning (2014) find that the
CoVaR defined as in Adrian and Brunnermeier (2011) underestimates
the contagion effect from the asset considered in distress to the financial
system, and the monotonic relationship with respect to the dependence
parameter does not hold. We denote their CoVaR with 𝐶𝑜𝑉 𝑎𝑅= .
We exploit GARCH models to compute 𝐶𝑜𝑉 𝑎𝑅= (under the assump-
tion of Gaussianity as 𝐶𝑜𝑉 𝑎𝑅=;𝛼,𝛽 = 𝜇𝑉 𝐼𝑋 𝑡 + 𝜎𝑉 𝐼𝑋 𝑡 𝜌𝑉 𝐼𝑋,𝑘𝑡 𝜙(𝛼)−1 + 𝜙
√ ) 𝑉 𝐼𝑋|𝑘𝑡
(𝛽)−1 1 − 𝜌2𝑉 𝐼𝑋,𝑘 . Specifically, we retrieve 𝜌𝑉 𝐼𝑋,𝑘𝑡 and 𝜎𝑉 𝐼𝑋 𝑡 fitting
𝑡 𝑡
the DCC-GARCH with bivariate Gaussian distribution on the log-returns
of the VIX and the commodity sector 𝑘. In the panels below (Figs. A.1,
A.2), we report the series of the 𝐶𝑜𝑉 𝑎𝑅𝛼,𝛽 𝑠𝑡 discussed in the paper
against the Gaussian CoVaR and the 𝐶𝑜𝑉 𝑎𝑅=;𝛼,𝛽 𝑠|𝑘𝑡
.
The panels show that both the Gaussian CoVaR and the 𝐶𝑜𝑉 𝑎𝑅=
severely underestimate the contagion effect of the commodity sectors to
the financial system. This is especially pronounced for the peaks of the
CoVaR occurring after 2011, suggesting the growing impact of fat tails
in commodity risks on systemic distress. The degree of underestimation
is generally homogeneous across the sectors. The estimates of the
Gaussian CoVaR are close to the 𝐶𝑜𝑉 𝑎𝑅= counterparts with notable
differences from the third decimal. This finding supports the robustness
of the estimation procedure adopted for the time-varying monitoring
of systemic risk. Therefore, assuming the Gaussian distribution intro-
duces a bias in the estimation of the systemic risk, which can be
practically approximated considering 𝑅𝑘𝑡 = 𝑉 𝑎𝑅𝛼𝑘 as the conditional
stress scenario. Such bias has a relevant impact on financial regulation,
potentially impaired by too loose capital requirements.

13
G. Morelli Energy Economics 117 (2023) 106446

Table A.1 Table A.3

Stochastic ordering of CoVaR exploiting the Gaussian distribution for the commodities Ranking of 𝐶𝑜𝑉 𝑎𝑅= exploiting the Gaussian distribution for the commodities in the
in the sample. We compute the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 which condition on sample. We compute the 𝐶𝑜𝑉 𝑎𝑅=;0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅=;0.05,0.05 which condition on the
the gains and losses exceeding the related VaR, respectively. In each column we report gains and losses exceeding the related VaR, respectively. In each column we report the
the absolute value of the CoVaR. Sample period: October 3, 2005–February 28, 2022.. absolute value of the CoVaR. Sample period: October 3, 2005–February 28, 2022..
CoVaR — Commodity, VaR0.95 𝑉 𝐼𝑋
= 0.1247 CoVaR — Commodity, VaR0.95 𝑉 𝐼𝑋
= 0.1247
𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05
Heating Oil 0.1328 Tin 0.1470 Heating Oil 0.1311 Tin 0.1421
Gasoline 0.1324 Canola 0.1249 Gasoline 0.1308 Canola 0.1249
WTI 0.1320 Oats 0.1248 WTI 0.1305 Oats 0.1248
Zinc 0.1313 Crude Palm Oil 0.1247 Zinc 0.1299 Crude Palm Oil 0.1247
White Sugar 0.1312 Rapeseed 0.1247 White Sugar 0.1299 Rapeseed 0.1247
Nickel 0.1304 Cotton 0.1244 Nickel 0.1292 Cotton 0.1245
Aluminium 0.1301 Corn 0.1240 Aluminium 0.1290 Corn 0.1242
Copper 0.1299 Wheat 0.1237 Copper 0.1288 Wheat 0.1239
Sugar 0.1294 Rough Rice 0.1234 Sugar 0.1284 Rough Rice 0.1237
Palladium 0.1292 Coffee 0.1234 Palladium 0.1283 Coffee 0.1237
Lead 0.1291 Rubber 0.1230 Lead 0.1282 Rubber 0.1233
Soybean Meal 0.1289 Natural Gas 0.1228 Soybean Meal 0.1281 Natural Gas 0.1232
Cocoa 0.1289 Gold 0.1228 Cocoa 0.1281 Gold 0.1231
Platinum 0.1287 Soybean 0.1223 Platinum 0.1279 Soybean 0.1228
Silver 0.1286 Low Sulphur Gasolio 0.1216 Silver 0.1279 Low Sulphur Gasolio 0.1222
EUA Emissions 0.1285 Soybean Oil 0.1213 EUA Emissions 0.1277 Soybean Oil 0.1220
Live Cattle 0.1283 Orange Juice 0.1212 Live Cattle 0.1276 Orange Juice 0.1219
Natural Gas UK 0.1282 Natural Gas UK 0.1212 Natural Gas UK 0.1275 Natural Gas UK 0.1219
Orange Juice 0.1282 Live Cattle 0.1211 Orange Juice 0.1275 Live Cattle 0.1218
Soybean Oil 0.1281 EUA Emissions 0.1209 Soybean Oil 0.1274 EUA Emissions 0.1217
Low Sulphur Gasolio 0.1279 Silver 0.1207 Low Sulphur Gasolio 0.1272 Silver 0.1215
Soybean 0.1272 Platinum 0.1206 Soybean 0.1267 Platinum 0.1215
Gold 0.1267 Cocoa 0.1204 Gold 0.1263 Cocoa 0.1213
Natural Gas 0.1266 Soybean Meal 0.1204 Natural Gas 0.1263 Soybean Meal 0.1213
Rubber 0.1265 Lead 0.1203 Rubber 0.1261 Lead 0.1212
Coffee 0.1260 Palladium 0.1201 Coffee 0.1258 Palladium 0.1211
Rough Rice 0.1260 Sugar 0.1200 Rough Rice 0.1258 Sugar 0.1209
Wheat 0.1257 Copper 0.1194 Wheat 0.1255 Copper 0.1205
Corn 0.1254 Aluminium 0.1192 Corn 0.1253 Aluminium 0.1203
Cotton 0.1250 Nickel 0.1189 Cotton 0.1250 Nickel 0.1201
Rapeseed 0.1247 White Sugar 0.1180 Rapeseed 0.1248 White Sugar 0.1194
Crude Palm Oil 0.1247 Zinc 0.1180 Crude Palm Oil 0.1247 Zinc 0.1193
Oats 0.1246 WTI 0.1172 Oats 0.1246 WTI 0.1187
Canola 0.1245 Gasoline 0.1167 Canola 0.1246 Gasoline 0.1183
Tin 0.1000 Heating Oil 0.1164 Tin 0.1046 Heating Oil 0.1180

Table A.2 Table A.4

Stochastic ordering of CoVaR exploiting the Gaussian distribution for Ranking of 𝐶𝑜𝑉 𝑎𝑅= exploiting the Gaussian distribution for the com-
the commodities in the sample. We compute the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 and modity sectors Agriculture (A), Energy (E), Industrial Metals (I), and
𝐶𝑜𝑉 𝑎𝑅0.05,0.05 which condition on the gains and losses exceeding the Precious Metals (P). We compute the 𝐶𝑜𝑉 𝑎𝑅=;0.95,0.05 and 𝐶𝑜𝑉 𝑎𝑅=;0.05,0.05
related VaR, respectively. In each column we report the absolute value which condition on the gains and losses exceeding the related VaR,
of the CoVaR. Sample period: October 3, 2005–February 28, 2022.. respectively. In each column we report the absolute value of the CoVaR.
CoVaR — Commodity, VaR0.95𝑉 𝐼𝑋
= 0.1247 Sample period: October 3, 2005–February 28, 2022..
𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 CoVaR — Commodity, VaR0.95𝑉 𝐼𝑋
= 0.1247
E 0.1327 I 0.1218 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 𝐶𝑜𝑉 𝑎𝑅0.05,0.05
A 0.1288 P 0.1207 E 0.1311 I 0.1223
P 0.1287 A 0.1206 A 0.1280 P 0.1215
I 0.1277 E 0.1164 P 0.1279 A 0.1214
I 0.1271 E 0.1181

These results are reflected when we build the stochastic ordering of

systemic risk in commodity markets. Tables A.1 and A.2 show that not
only is the ranking altered, but the magnitude of the CoVaR is sharply
curtailed. For the upside risk, the maximum value in the  -ranking
of the 𝐶𝑜𝑉 𝑎𝑅0.95,0.05 does not even reach the minimum value observed
in the -ranking. For the downside risk, the maximum contribution
to the systemic risk is more than two times the maximum contribution
in the  -ranking of the 𝐶𝑜𝑉 𝑎𝑅0.05,0.05 . The fact that the -VaR of
the VIX does not remarkably differ from the  -VaR highlights the
inaccuracy of the Gaussian distribution to gauge the contagion effect
of the commodities to the financial system. The lack of consideration
of tail events and skewness in the Gaussian distribution distorts the
strength of the relationship between the commodities and the financial
system, causing top systemic contributors, such as WTI and EUA, not to
be fairly ranked. The upside risk  -stochastic ordering corresponds to
the reverted downside risk  -stochastic ordering. This is an immediate
consequence of the symmetry of the Gaussian distribution. When the
skewness parameter is included, the change of the conditional event
in the computation of the CoVaR produces different rankings due
to the different weight associated with events occurring at the tails.
The inclusion of stylized facts into the methodology thus fosters the
proper depiction of the underlying asymmetry in downside and up-
side commodity risks. Besides the underestimation and the inaccurate
ranking of systemic risk, the estimates of the Gaussian CoVaR are also
more homogeneous compared to the  counterparts, therefore not
detecting heterogeneity among commodity risks.
Tables A.3 and A.4 show the ranking of the 𝐶𝑜𝑉 𝑎𝑅= . Consistently
with Mainik and Schaanning (2014), the discrepancy between the
Gaussian CoVaR and the Gaussian 𝐶𝑜𝑉 𝑎𝑅= increases as the contribu-
tion to the systemic is more pronounced, remarking the importance
of robust systemic risk measures from both theoretical and practical
perspectives. Despite the underestimation, the Gaussian CoVaR does
not highly depart from 𝐶𝑜𝑉 𝑎𝑅= , validating the methodology employed
in the paper for the computation of the CoVaR.

14
G. Morelli
Appendix B. Supplementary data
Supplementary material related to this article can be found online
at https://doi.org/10.1016/j.eneco.2022.106446.
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