International Conference On Applied Economics ICOAE 2010 573

MEAN REVERSI ON AND SEASONALI TY I N GARCH OF AGRICULTURAL COMMODI TI ES

KOMKRIT OVARARIN
1
- NIGEL MEADE
2

Abstract
In this article we model the returns volatility on 3 agricultural commodities, rough rice, rubber and white sugar. We investigate mean
reversion and seasonality. A GARCH model is used to capture volatility clustering. There are several patterns of seasonality. For
instance, a day-of-the-week seasonality represents investor behaviour in the futures markets and yearly seasonality demonstrates the
effect of the harvest. We find no evidence of mean reversion in our samples. Seasonal patterns dominate in the volatility estimation-
GARCH (1,1) with seasonality in mean equation and GARCH (1,1) with seasonality in mean equation and volatility. Therefore, the
seasonality is a crucial determinant providing more realistic volatility model for agricultural products.
JEL codes: C10, C220, Q140
Key Words: Mean reversion; Seasonality; Agricultural commodities; GARCH
1 Introduction
In the last decade, many researchers offer contributions to finance agricultural research by explaining price behaviour, the
volatility process and convenience yield.
We have found that the volatility process is an important element in both pricing and risk management. Constant volatility is a
primary assumption in pricing procedure; however, counter evidence has been raised by many quantitative papers. They suggest that
time-varying volatility model provides better risk measurement.
Prices and volatility of agricultural products have distinctive features from other financial products. That mean reversion and
seasonality of many agricultural products are general characteristics have been detected in research papers.
The main objective of this paper is to study volatility models. The proposed volatility models have been modified from the
generalized autoregressive conditional heteroskedasticity (GARCH) model which is used to evaluate the volatility behaviour of
agricultural commodity.
The extensions of GARCH model are generated by including the mean reversion and seasonality in mean equation and volatility
process. The results indicate that the seasonality components exist in both mean equation and volatility process. The proposed
conditional volatility model with seasonality seems to be a realistic pricing model for agriculture.
The remainder of this paper is structured as follows. Section 2 provides the critical literature reviews of the related subjects. The
used data and the methodology will be explained in the section 3 and 4. In section 5, the estimated parameters are presented and
discussed. The conclusion of this paper is given in the last section.
2 Previous Research
Volatility forecasting is an important fundamental element in investment strategy, option pricing and risk management. This is an
indicator by which the price changes in the financial market. Poon and Granger (2005) conduct a volatility review over the last 20
years. The comparisons of 93 volatility studies indicate that the implied volatility model provides the best performance, following by
the GARCH and the historical volatility model. However, the performance of volatility model is not dominated by one model
according to the mixed results in many papers.
Many researchers apply the ARCH-family volatility model in financial market, particularly in commodity market, such as Oglend
and Sikveland (2008), Huang et al. (2009). Moreover, Samuelson (1965) states that the volatility of agricultural future prices
increases while the time to maturity decrease. This property is well known as Samuelson Effect.
Additionally, there are many evidences to support the time-varying volatility model is more suitable to incorporate in the pricing
or risk management. For instance, Tian and Fackler (2000) claim that the constant volatility is assumed in diffusion factor models for
future price is known to be unsatisfactory in commodity markets. Power and Turvey (2008) also present a long-range dependence in
the price volatility of many commodity and agricultural futures prices. They test a null hypothesis of Hurst coefficient is equal to 0.5
which imply to a Geometric Brownian Motion of 14 samples of commodity and agricultural future prices. The results indicate that all
series are rejected, meaning all future price volatility has a long memory process.
Mean reversion is the process of the price approaching a long term mean. This is inconsistent with a random walk. The concept of
mean reversion, which is popularly used in many fields, has been found in 1930 by Ornstein-Uhlenbeck. For example, Cadenillas et
al (2007) contribute an optimal dividend policy strategy by assuming a mean reverting process in cash reservoir of financial
company. Coporale and Gil-Alana (2009) analyse daily structure of 1, 3, 5, 7 and 10 US Treasury constant maturity rate by using
fractional integration techniques.
In commodity literature, the first proposal of mean reverting process in commodity pricing is addressed by Schwartz (1997). He
compares the performance of three models that take into account mean reverting with stochastic process. Then, the conclusions
suggest that mean reversion should be considered in the financial decision, in order to obtain the realisable numbers. Moreover, there
have been any financial commodity papers related with mean reversion (see, e.g., Tomek and Peterson (2001), Cartea and Figueroa
(2005), and Miltersen (2003)).

1
Doctoral research student, Imperial College Business School , London; E-mail k.ovararin08@imperial.ac.uk
2
Professor of Quantitative Finance, Imperial College Business School, London; E-mail: n.meade@imperial.ac.uk

574 International Conference On Applied Economics ICOAE 2010


Next, the seasonality of agricultural products is an essential feature because of production periods and climate changes. Robert
(2001) states that production of agricultural product has a distinctive behaviour in commodity price, as a result of a seasonality
pattern in production. Therefore, seasonality is a one of the empirical characteristics that distinguish some agricultural commodities
from the other financial assets. Stifel and Randrianarisoa (2006) state that significant seasonality is exhibited in price series and
volatility process of agricultural products, such as rice, maize and cassava in Madagascar.
Moreover, Tomek and Peterson (2001) also suggest that the demand or supply for an agricultural product is a major cause of
seasonality in spot prices, which is as same as Karali and Thurman (2009). Furthermore, Borovkova and Geman (2007) claim that the
agricultural prices exhibit the seasonal pattern are driven by seasonal supply. The upward price movement are always shown before
the harvest. They also suggest that the other commodity prices, such as gas and electricity, represent the seasonality. There are many
research papers that related with the agricultural product, for example, Malick and Ward (1987) study frozen concentrated orange
juice and Netz (1996) investigates the seasonal effect in corn. Their empirical results confirm the existence of seasonality.
3 Data
We describe the analysis of time series of commodities prices series, namely rubber, rough rice and white sugar. We investigate
the presence of the effects discussed in the previous section; volatility, mean reversion and seasonality. All data are collected from
DataStream.
The near month future prices are collected as a proxy of the spot price for agricultural products from the most active trading
market on each sample. Firstly, the rubber future settlement prices at Tokyo Commodity Exchange set extends over the period 1st
January 1991 31st December 2009. There are 4958 daily observations which are recorded every weekday. Thus, there are 260 days
a year. Secondly, the 2349 daily observations of rough rice future settlement prices at Chicago Board of Trade in the period 1st
January 2001 to 31st December 2009. Finally, the white sugar future settlement prices at Euronext.liffe, London are in the period 1st
January 1996 to 31st December 2009 which consists of 3654 daily observations.
Table 1 provides the summary statistics of daily logarithm return of three commodities. There are wide differences across three
samples. For average daily return, the highest rubber average return is on Monday and lowest average return is on Wednesday. The
mean rough rice returns are all positive expect Tuesday. The maximum return occurs on Friday. The last sample returns have a peak
on Friday, and reach a bottom on Monday.
The skewness value is a measure of the asymmetry of the probability distribution. All these samples present the negative
skewness or left-skewed which are -0.24, -0.30, -0.91 of the rubber, rough rice and white sugar respectively. The rubber return
demonstrates the lowest kurtosis which is 2.75; on the other hand, the rough rice and white sugar returns show the leptokurtic
distribution.
Table 19: Moment of the distribution by day of the week

Source: Thomson Reuters DataStream
4 Methodology
4.1 Generalized autoregressive conditional heteroskedasticity (GARCH) model
This paper is bases on the popular volatility model which is the generalized autoregressive conditional heteroskedasticity
(GARCH model), introduced by Bollerslev (1986). We start by defining the daily log return of agricultural future prices as the
change of the logarithm of the daily closing of future prices. The daily log return can be written as
) ln( ) ln(
1 t t t
P P y

(5)
A discrete-time log daily return is assumed for this paper, giving the form of mean equation and the error term process as
following
t t
y
(6)
t t
y
(7)
where the error term is a function of the log daily return and the unconditional mean. These equations are the starting equations
for the following assumptions. To examine the effect the mean reversion and the seasonality, the simplest generalized autoregressive
conditional heteroskedasticity (GARCH) is utilized to estimate the parameters in which is expressed as follows:
International Conference On Applied Economics ICOAE 2010 575


( ) ( )
2
1
2
1
2

+ + =
t t t
o | c o e o
(8)
where >0, ,>0 and + <1. These restrictions represent important information for the volatility model. First, the mean of
volatility will not be negative value. The coefficiency of previous volatility and noise term are positive estimations that depict the
stylised fact of volatility clustering. Moreover, the sum of and measures the persistence of a shock to the variance which shows
the mean reversion characteristic of volatility model.
4.2 GARCH (1,1) with mean reversion process in mean equation
The second approach attempts to modify the volatility model by adding mean reversion process of Ornstein-Uhlenbeck (1930) to
the mean equation (2). Mean reversion is generally introduced into the model by the drift term. The GARCH (1,1), thus, with mean
reversion in mean is given by
) ( )) ln ( (
2
1
2
1 1
2

+ + =
t t t t
P a y o | o e o
(9)
4.3 GARCH (1,1) with seasonality in mean equation
Moreover, this paper introduces a seasonal pattern into the mean equation as represented in term of the trigonometric function
was introduced by Hannan, Terrell, and Tuckwell (1970) to offer the alternative approach to model the seasonality. The
trigonometric deterministic seasonal process can equivalently be written in the mean equation as
( ) ( ) | |

=
+ + + =
*
1
2 2
sin cos
K
k
t S
kt
k S
kt
k t
y c |
t t
(10)
where k representing the number of term in the sum,
k
and
k
is the coefficient estimated and S is the number of observations
in one period, for example, s=5 for daily observation when estimating the day-of-the-week effect and s=260 for daily observations
when estimating the yearly seasonal effect.
According to the trigonometric representation of seasonality, the GARCH model will be modified from the original. This
representation of seasonal modelling is chosen because it is convenience to capture the dynamic of high frequency observations.
Thus, the GARCH (1,1) with trigonometric representation of weekly and yearly seasonality is represented in the forms as follows:
( ) ( ) | |
( ) ( ) | | ( )
2
1
2
*
1
260
2
260
2
2
1
5
2
5
2
1
2
)) sin cos
sin cos ( (

=
=

+ + +
+ + + =

t
yk
yk
kt
k
kt
k
wk
kt
wk
kt
wk t t
y
o |
o e o
t t
t t
(11)
In addition, this model also captures the yearly seasonality; therefore, the estimated parameters of yearly seasonality have been
defined and K optimal is chosen from the Akaike Information Criterion (AIC).
4.4 GARCH (1,1) with seasonality in mean equation and volatility
The last approach of this paper desires to contribute the conditional volatility model which captures both importance features in
mean equation and GARCH specification. The extending conditional volatility model is begun from the optimal GARCH with the
day-of-the week seasonality. This model also captures the effect of day-of the week and monthly seasonality as represented in
( ) ( ) | |
( ) ( ) | | ( )
( ) ( ) | | ( ) ( ) | |)) sin cos ) sin cos , 0 max(
)) sin cos
sin cos ( (
*
1
5
2
260
2
2
1
5
2
5
2
2
1
2
*
1
260
2
260
2
2
1
5
2
5
2
1
2

= =

=
=

+ + + +
+ + +
+ + + =
vyk
vyk
kt
vyk
kt
vyk
vwk
kt
vwk
kt
vwk
t
myk
myk
kt
myk
kt
myk
mwk
kt
mwk
kt
mwk t t
y
t t t t
t t
t t

o |
o e o
(12)
According to the condition of variance restriction, the value of conditional variance cannot be a negative value. Therefore, the
restriction of the non-negative value of the sum of the trigonometric terms is settled by accepting the maximum value between the
seasonal components of volatility and zero.
The unconditional long run constant variance is given by,
) ( 1
2
| o
e
o
+
= is used initialize the GARCH variance. All estimations
are preformed in MATLAB. The estimation initially processes the condition variance equation using the log-likelihood function. The
common method to calibrate the parameters is to maximize the likelihood function which is
( )) exp ln( max ) ln( max ln max
2
2
2
2
2
1

H
= =
T
t
y
t
t
t
t
l L
o
o
(13)
5 Empirical Results and Discussion
The empirical results of all models of individual sample are explained. The rubber future prices estimations in four composed
models are entirely explained, then, section 5.2 presents the brief explanations of rough rice and white sugar. Finally, weekly and
yearly seasonal graphs would be discussed.
576 International Conference On Applied Economics ICOAE 2010


5.1 Rubber
5.1.1 GARCH (1,1) Model
The GARCH model parameters are represented in the table 2. The drift term of variance process is 0.000008. The value of the
parameter is 0.907986 which indicates a time varying volatility having long memory for rubber future return. Moreover, the sum of
and is being 0.982591 which imply a volatility half life of about 40 days. In addition, the value of the drift term of return process
is 0.000378. All parameters are significances as the value of t-statistic greater than 1.96 at 95% confidence level. The log-likelihood
is 12494.00.
5.1.2 GARCH (1,1) with Mean Reversion Process in Mean Equation
From these results, the speed of reversion parameter which used to capture the mean reversion process of log daily return process
is insignificant, based on the t-statistic. This implies that the log daily return process not presents the mean reversion feature, thus it
not optimal to include the mean reversion parameters of log return process in the second moment.
Moreover, the log-likelihood of the GARCH with mean reversion is lower than the original GARCH. This situation is caused by
adding not optimal parameters in the model. This implies that the GARCH with mean reversion in mean equation provides less
accuracy volatility forecasting model.
5.1.3 GARCH (1,1) with Trigonometric Representation in Mean Equation
Furthermore, the third column of table 2 illustrates the calibrating results of the GARCH with seasonality in mean equation as
shown in equation 7. There are four estimated parameters representing the day-of-the-week by indexing Monday, Tuesday,
Wednesday and Thursday respectively. The number of the sum, describing a weekday seasonality, is K=2.
In addition, this model also captures the yearly seasonality; therefore, the estimated parameters of yearly seasonality have been
defined and K optimal is chosen from the Akaike Information Criterion (AIC). The lowest AIC points out that the optimal yearl y K
of rubber future return is K=5. Hence, there are 10 estimated parameters for yearly seasonality.
All four parameters of the weekly seasonality in mean equation are significances. These imply that the repeat of price movement
is the consequence of the investors trading behaviour or some regulated event in the futures markets.
Table 20 : The Rubber Estimated parameters of all Time-varying Models
GARCH
(1,1)
GARCH
(1,1) with
Mean
Reversion
Process
GARCH (1,1)
with
Trigonometric
Representation
in Mean
Equation

GARCH (1,1) with
Trigonometric
Representation in Mean
Equation and Volatility
0.000008*
(0.000001)
0.000008*
(0.000001)
0.000008*
(0.000001)
0.000009*
(0.000001)
0.074605*
(0.003207)
0.073962*
(0.010841)
0.07529*
(0.004065)
0.03823*
(0.00184)
0.907986*
(0.004312)
0.908946*
(0.010184)
0.907661*
(0.004786)
0.903201*
(0.004588)
a 0.000378*
(0.000127)
6.21E-09
(0.000273) - -


-0.01815*
(0.000061)


0.000343*
(0.000132)
0.000339*
(0.000126)
mw1 0.000761*
(0.000193)
0.000741*
(0.000179)
mw1 0.000452*
(0.000189)
0.000453*
(0.000175)
mw2 -0.00042*
(0.00019)
-0.000429*
(0.000178)
mw2 -0.00042*
(0.000191)
-0.000420*
(0.000178)
my1

0.000693*
(0.000197)
0.000666*
(0.000179)
my1

0.000788*
(0.000198)
0.000778*
(0.000176)
my2

0.000151
(0.000198)
0.000133
(0.000174)
my2

-0.00031
(0.000192)
-0.000311
(0.000183)
my3

0.000441*
(0.000186)
0.000417*
(0.000185)
my3

0.001123*
(0.000203)
0.001112*
(0.000173)
International Conference On Applied Economics ICOAE 2010 577


my4

-0.00011
(0.000195)
-0.000125
(0.000178)
my4

0.000372
(0.000192)
0.000360*
(0.000183)
mw5

0.000684*
(0.000196)
0.000671*
(0.000178)
my5

-0.00077*
(0.000195)
-0.000793*
(0.000177)
vw1 -0.157727
(0.483818)
vw1 0.328179
(0.491524)
vw2 0.259494
(0.497672)
vw2 0.059823
(0.477492)
vy1 0.656322
(0.475053)
vy1 -0.026395
(0.496932)
vy2 -0.006261
(0.475053)
vy2 0.033047
(0.489187)
vy3 -0.007203
(0.475053)
vy3 0.269616
(0.480551)
vy4 0.456322
(0.475053)
vy4 0.870596
(0.425173)
vy5 -3.413193
(0.475053)
vy5 0.863452
(0.41735)
Log-
likelihood
12494.00 12492.89 12503.65 12509.63
AIC -24991.30 -24963.27
Note: Standard errors in parentheses, * indicates significance at 95% confidential level
Moreover, six-tenths estimated parameters of yearly seasonality in mean equation are significances. There are more positive
coefficients, this causes to a high conditional variance when take an account of the yearly seasonality. This phenomenon is not a
surprise since in general the high seasonal affect induces the high volatility of the return.
Furthermore, the log-likelihood of this model rises from 12492.89 to 12503.64. This means that there are improvements when
including the seasonality in mean equation.
5.1.4 GARCH (1,1) with Trigonometric Representation in Mean Equation and Volatility
The last model considered is the GARCH (1,1) with seasonality in mean equation and volatility. This model is an extension of the
previous optimal GARCH (1,1) with seasonality in mean equation which is represented in equation 8.The optimal K of seasonal
volatility as exogenous volatility variable is chosen from the lowest AIC.
Table 2 represents the estimated value of the GARCH (1,1) with seasonality in mean equation and volatility. There are 32
estimated parameters regarding to the lowest AIC. The K optimal for seasonal volatility is 5. The adding parameters from the last
equation consist of 4 weekly seasonal-volatility and 10 yearly seasonal-volatility parameters.
According to the t-statistic, three-tenths yearly seasonal volatility variables are significances. For the seasonality in mean
equation, seven-tenths seasonal variables are significances. These findings indicate that the yearly seasonality exist in the conditional
volatility model as commonly see in the agricultural commodities. The log-likelihood value of this model is 12509.63 which is higher
than the GARCH (1,1) with seasonality in mean equation.
All weekly seasonal parameters in mean equation are significances. On the other hand, all weekly seasonal volatility parameters
are not significant. This seems that there is seasonality in the log daily return, probably due to the investors behaviours in the future
market during the week, however, these actions do not effect to the volatility process. Furthermore, the seasonal components in the
mean equation have more strong effect than the seasonality in volatility.
578 International Conference On Applied Economics ICOAE 2010


5.2 Rough Rice and White Sugar
The estimated parameters of rough rice future prices and white sugars are shown in table 3. This table provides the estimated
coefficients and the standard error of individual sample from the calibrations. Moreover, the statistic values for making decision,
which is AIC, are displayed in the tables when estimate the seasonality in mean equation and volatility model.
5.2.1 GARCH (1,1) Model
Table 3 shows GARCH (1,1) parameters of rough rice future prices. All parameters are significances at 95% confident level. The
drift term is 0.000053 and the sum of and is 0.846097. These imply that the volatility half life is about 5.15 days which is quickly
than the rubber. This figure also presents the time for volatility to move half-way back to its mean.
Table 21: Rough rice and White sugar Estimated Parameters
Rough Rice White Sugar
GARCH
(1,1)
GARCH
(1,1) with
Mean
Reversion
Process
GARCH (1,1)
with
Trigonometric
Representatio
n in Mean
Equation

GARCH (1,1)
with
Trigonometric
Representatio
n in Mean
Equation and
Volatility
GARCH
(1,1)
GARCH
(1,1)
with
Mean
Reversio
n Process
GARCH (1,1)
with
Trigonometric
Representation
in Mean
Equation

GARCH
(1,1) with
Trigonometri
c
Representati
on in Mean
Equation and
Volatility

0.000053*
(0.000007)
0.000056*
(0.000008
)
0.000051*
(0.000006)
0.000139*
(0.000003)
0.000029*
(0.000003)
0.000029
*
(0.00000
3)
0.000028*
(0.000003)
0.000025*
(0.000003)

0.150219*
(0.010391)
0.147534*
(0.011220
)
0.148910*
(0.011662)
0.139034*
(0.010877)
0.216713*
(0.012198)
0.216790
*
(0.01222
7)
0.219747*
(0.012343)
0.209738*
(0.012437)

0.695878*
(0.027310)
0.691436*
(0.029746
)
0.703818*
(0.027181)
0.697652*
(0.027131)
0.701772*
(0.017090)
0.701424
*
(0.01644
1)
0.700818*
(0.016696)
0.702549*
(0.021006)
a
-
0.000000
(0.000004
) - - -
0.000023
(0.00001
9) -
0.000880*
(0.000176) -
0.037592*
(0.000173
)
0.000870*
(0.000177)
0.000530*
(0.000214)
-0.000140
(0.000111)
-
0.046495
*
(0.00033
7)
-0.000158*
(0.000110)
-0.000138
(0.000114)
mw1 0.000928*
(0.000247)
0.001119*
(0.000319)
0.000688*
(0.000155)
0.000806*
(0.000166)
mw1 -0.000384
(0.000258)
-0.000616*
(0.000293)
-0.000580*
(0.000156)
-0.000572*
(0.000175)
mw2 0.000019
(0.000250)
0.000731*
(0.000280)
0.000538*
(0.000157)
0.000557*
(0.000180)
mw2 0.000736*
(0.000243)
0.000733*
(0.000240)
0.000110
(0.000156)
0.000125
(0.000180)
my1 0.000328
(0.000251)
0.000413
(0.000333)
0.000183
(0.000153)
0.000219
(0.000176)
my1 0.000385
(0.000252)
0.001002*
(0.000259)
0.000371*
(0.000155)
0.000337*
(0.000162)
my2
-
0.000522*
(0.000153)
0.000483*
(0.000179)
my2
-
-0.000992*
(0.000154)
-0.001050*
(0.000185)
vw1 -0.000026*
(0.000010)
-2E-06
(0.000002)
vw1 0.000041
(0.000028)
0.000002
(0.000002)
vw2 0.000061
(0.000034)
-2E-06
(0.000003)
vw2 0.000076* -1E-06
International Conference On Applied Economics ICOAE 2010 579


Note: Standard errors in parentheses, * indicates significance at 95% confidential level
The GARCH (1,1) parameters of white sugar future prices are represented in right half-column of table 3. The , and are
significances at 95% confidence level. However, the t-statistic on sugars mean which is equal to -1.26 indicates that the null
hypothesis cannot be rejected. The drift term is 0.000029 and the sum of and is 0.918485. Therefore, the volatility half life is
about 9.15 days being quickly than the rubber but has more persistence than the rough rice. The log-likelihood is 10144.85.
5.2.2 GARCH (1,1) with Mean Reversion Process in Mean Equation
The hypothesis of mean reversion in mean exist in the GARCH (1,1) is examined and the results of rough rice confirm that the
insignificant speed of reversion estimations have been found on both samples. These results match with the rubber futures prices;
therefore, the mean reversion in mean is not fit on the conditional volatility.
5.2.3 GARCH (1,1) with Trigonometric Representation in Mean Equation
For rough rice futures prices, the lowest AIC have been found when K=1. The main parameters of GARCH (1,1) are
significances. Moreover, only Monday and Thursday illustrate the repeated pattern in the week, thus investors in the rough rice
futures markets can forecast the same occurrences on Monday and Thursday. The yearly seasonality parameters do not present any
significance. The including of seasonality in mean equation leads to the higher conditional volatility as the coefficients of the
significant parameters are positive values.
The white sugar estimations consist of GARCH (1,1) elements, 4 weekly seasonality parameters and 4 yearly seasonality
parameters, according to the lowest AIC. Three-fourths of weekly seasonality parameters are significant which represent Monday,
Tuesday and Thursday. In addition, more than a half of yearly seasonality parameters are significances.
Moreover, the greater log-likelihoods have been found of both rough rice and white sugar. The log-likelihood of rough rice is
6166.16 and the log-likelihood of white sugar is 10157.83 which are bigger than the previous models. This shows the improving
model when includes the seasonality into the conditional volatility model.
5.2.4 GARCH (1,1) with Trigonometric Representation in Mean Equation and Volatility
This model is an extension of the optimal seasonality in mean equation model. The construction of GARCH (1,1) with seasonality
in mean equation and volatility of rough rice and white sugar resembles the rubber modelling , so there are eight weekly seasonality
parameters which composes of four parameters for mean equation and the rest for volatility. The yearly seasonality parameters in
volatility, then are chosen by the lowest AIC which has been found when K equal to 6. Therefore, there are 26 estimated parameters
in the rough rice equation. For white sugar, the lowest AIC has been found when K equal to 2, so there are 20 parameters.
From calibration, the weekly seasonality parameters in mean equation seem appropriate variables to involve in the rough rice
conditional volatility model. Moreover, the yearly seasonality parameter is also significant at 95% confidence level. Furthermore,
many seasonality parameters of volatility process are also significances. The log-likelihood is 10164.92, which is greater than the
previous model. This volatility model can capture the seasonality of both the price and volatility processes.
The results of white sugar do not distinguish from the rubber and white sugar which indicate the existence of seasonality in the
volatility model. The adding parameters provide more appropriate volatility prediction. The weekly seasonality parameters in mean
equation are significances as same as the model without seasonal volatility.
(0.000020) (0.000002)
vy1 -0.000078*
(0.000014)
0.000002
(0.000004)
vy1 -0.000006
(0.000017)
-6E-06
(0.000003)
vy2 0.000018
(0.000023)
-0.00001*
(0.000004)
vy2 0.000010
(0.000023)
-7E-06*
(0.000001)
vy3 -0.000077
(0.000012)

vy3 0.000042
(0.000030)

vy4 0.000019
(0.000017)

vy4 0.000028
(0.000015)

vy5 0.000010
(0.000020)

vy5 0.000039*
(0.000020)

vy6 0.000110*
(0.000019)

vy6 0.000075*
(0.000021)

Log-
likeliho
od
6162.30 6159.08 6166.16 6198.67 10144.8
5
10144.79 10157.83 10164.92
AIC -12312.32 -12345.35 -20291.65 -20289.80
580 International Conference On Applied Economics ICOAE 2010


However, according to the results, the weekly seasonal parameters of volatility are not important to be taken into a consideration.
There are not significant at 95% confidence interval. On the other hand, half of yearly seasonality parameters are significance. These
cause a reduction of volatility estimation because most of coefficients are negative value.
Now the forms of seasonal patterns are displayed in the figure 1. These seasonal patterns are plotted by substituting the estimated
parameters in table 2 and 3 for rubber, rough rice and white sugar into the trigonometric representations.
For rubber, the seasonal pattern shows the fluctuated curve, due to the uncertainty of production supply. Basically, the planting of
rubber trees are about 5-6 years old, and then the first harvest would be begun.
The highest rubber return has been found in May due to the shed leaves of rubber tree and the reduction of production in summer
which start from April. The large amount of latex would be collected at the beginning of raining season that is June; however, if there
is a heavy rainfall, it will be a seriously effect to the harvesting process. This produces diluted latex which is unqualified products.
Therefore, the price of rubber will climb to the high point again in the beginning of October. The rubber price seasonal movement is
not resulted only from the supply condition, but it also is affected from the demand condition. The high demand in the world rubber
market is usually in January especially from China, so this leads to the high rubber price in January.
For rough rice, the seasonal curve is presented smoother curve than other samples because there are more rice stocks, due to the
whole year production. There are two main time-periods of a rice production planting in late May and early December for rained rice
and off-season rice respectively. The rice is growing within 3-4 months, thus the harvesting season is between August to September
and February to March. These lead to low seasonal component in February and August, because of the high supply. The graph
indicates that the peak have been found in May and November that are one month before planting. However, the seasonality
parameters are insignificances as results of GARCH (1,1) with seasonality in mean equation. Thus, yearly seasonality parameters of
rough rice are an inappropriate expresser of the price movement during the year.
Figure 12: The estimated yearly seasonal patterns of rubber, rough rice and white sugar by substituting the estimated
parameter into the trigonometric representative function

The last seasonal pattern is the curvature of white sugar. As you know, white sugar is produced from the sugarcane. Famers prefer
to start their planting during May-July for began-rain sugarcane and in December-February for ended-rain sugarcane, they require
10-14 months for growing. The harvesting period for sugarcane begins in July-August and February-March for began-rain sugarcane
and the ended-rain sugarcane, respectively. Therefore, the seasonal pattern graph illustrates the peak in May and November, taking
place 2-3 months before harvest.
Figure 2 illustrates the day-of-the-week seasonality of rubber, rough rice and white sugar. For rubber, the day-of-the-week peaks
on Monday and reach the bottom on Wednesday. For rough rice and white sugar, the day-of-the-week peaks on Friday, in addition,
the lowest points have been found on Tuesday for rough rice and on Monday for white sugar. These weekly seasonality graphs
present the highest and lowest points which are similar to the data summary in Table 1. Therefore, the weekly seasonality parameters
in modified GARCH (1,1) model perfectly capture the price movement during the week. The situations have been found when
trading behaviours in the future market is set to be an assumption of the model.
Figure 13: The estimated weekly seasonal patterns of rubber, rough rice and white sugar by substituting the estimated
parameter into the trigonometric representative function

6 Conclusion
This paper aims to model the returns volatility models with the mean reversion and seasonality on 3 agricultural products,
namely, rubber, rough rice and white sugar.
GARCH model is used to incorporate the mean reversion and seasonality. From the literature, there are 2 patterns of seasonality,
namely, a day-of-the-week seasonality and yearly seasonality. The day-of-the week seasonality represents the investor behaviour in
the futures markets and the yearly seasonality illustrates the harvest and lean period of the agriculture.
Firstly, the mean reversion and seasonal pattern are assumed in the price process which used to estimate the volatility. The error
term of the price process is including these two features, and then substituting in the GARCH (1,1). The existence of seasonality in
International Conference On Applied Economics ICOAE 2010 581


volatility process has been raised as a second assumption of this paper. The second volatility model is an extension model from the
optimal GARCH (1,1) with the seasonality in mean equation.
Three types of nearest daily future contract prices are collected from the different future markets which are Tokyo Commodity
Exchange, Chicago Board of Trade and Euronet for rubber, rough rice and white sugar respectively. In addition, the estimated
parameters of all models are generated by using the maximum likelihood function.
The results present that the mean reversions in mean equation of three observations are not significances in the volatility process.
On the other hand, seasonal patterns dominate in the volatility estimation- GARCH (1,1) with seasonality in mean equation and
GARCH (1,1) with seasonality in mean equation and volatility. Therefore, the seasonality is an important additional parameter which
provides more realistic volatility model for agricultural products. For the future research, it is very interesting to utilize this volatility
process in financial risk management tools, such as value at risk (VaR), and be incorporated in pricing model.
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