The Interdependency of Asset pricing on Prices of Its Substitutes: Application to Cocoa, Coffee and Tea
In this paper we examine the behaviour of the prices, of Cocoa, Coffee and Tea as beverages (substitutes). We also investigate if the pricing of one asset is influenced by the prices of any of the other assets. Using Akaike Information Criterion (AIC), Schwarz Information Criterion (SIC) for selecting the best model out of all the competing models, the best models fitted were, Cocoa prices being ARIMA (0, 1, 2), Coffee prices ARIMA (1, 1, 1) and Tea prices ARIMA (0, 1, 0) respectively. Thus, all the three variables were integrated of order I (1), Using Johansen cointegration test, we observed that there was at most one cointegration equation, among these assets, indicating that there is a long-run equilibrium among the pricing of the prices of Cocoa, Coffee and Tea. Analysis of the Granger causality test shows that there is Granger causality between all the three variables; hence there is a long run association among prices of cocoa, coffee and tea. Also from the cross correlation matrix it was observed that all the three variables were positively correlated with cocoa and coffee having a very high correlation of 0.8. This indicates a probable higher dependency of the pricing of these two assets on the price of the other. Due to the cointegration, Vector Error Correction model (VECM) was used to estimate the equation relating the prices of Cocoa, Coffee and Tea.
Cointegration, Long-Run Equilibrium, Correlation Matrix, Normality, VECM
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