German Rapeseed Oil and Biodiesel Pricing under Changing Market Conditions: A Markov-switching Vector Error Correction Model Approach

We analyze vertical price transmission in the German biodiesel market studying therelationship between rapeseed oil, soya oil and biodiesel prices. We focus on the period fromsummer 2002 to late 2007 during which the German biodiesel market developed into thelargest market worldwide, mainly driven by political intervention. Tests on the adequacy of atraditional linear vector error correction model provide strong evidence against it and favor aregime-dependent model. We consider the Markov-switching vector error correction modelwhich allows for parameter switching between regimes to be suitable for the question to beanalyzed. We find two distinct regimes with differing error-correction behavior. Estimationresults indicate that only rapeseed oil prices adjust deviations from the long-run equilibriumbetween the three prices. Error-correction is found to be strong until 2005; however, itsubstantially weakens in 2006 and 2007 due to market distorting policy measures such asblending obligations and norms requiring the use of rapeseed oil.