Analysis of price volatility and discovery mechanisms in Pakistan mercantile exchange: focus on crude oil, cotton, and exchange rates

Abstract

Commodity markets are pivotal for economic stability, particularly in emerging economies like Pakistan, where the Pakistan Mercantile Exchange (PMEX) serves as a critical platform for trading energy, agricultural commodities, and currencies. However, price volatility and interdependencies between key commodities like crude oil, cotton, and exchange rates remain underexplored, posing risks for investors and policymakers. This study examines volatility dynamics and price discovery mechanisms at PMEX to address this gap. Using daily data (2013–2022), we employ Vector Error Correction Models (VECM) to analyze long-run equilibrium relationships and Generalized Autoregressive Conditional Heteroskedasticity (GARCH) to quantify volatility persistence. Results reveal a significant cointegrating relationship (trace statistic=43.66), with exchange rates acting as the primary adjustment mechanism (coefficient=0.08, p<0.01). Short-run dynamics show exchange rates strongly influence crude oil prices (coefficient = 38.74, p < 0.01) and cotton prices (coefficient=-0.08, p=0.05). The GARCH (1, 1) model confirms high volatility persistence (β₁=0.78) and shock sensitivity (α₁=0.20), indicating prolonged volatility clusters. These findings underscore the centrality of exchange rates in PMEX’s price discovery process and highlight actionable insights for hedging and policy formulation. The study contributes a novel framework for emerging markets by integrating volatility and cointegration analyses, offering traders strategies to mitigate currency-linked risks and guiding regulators in stabilizing commodity markets during external shocks.