Dependence and extreme dependence of crude oil and natural gas prices with applications to risk management

In this article, we show how the copula-GARCH approach can be appro- priately used to investigate the conditional dependence structure between the crude oil and natural gas markets as well as to derive implications for port- folio risk management in extreme economic conditions. Using daily price data from January 1997 to October 2011, our in-sample results show evi- dence of asymmetric dependence between the two markets. The crude oil and gas markets tend to co-move closely together during bullish periods, but not at all during bearish periods. Moreover, taking the extreme comovement into account leads to an improvement in the accuracy of the out-of-sample Value-at-Risk forecasts.