Rare Earth Metals' Resiliency and Volatility Spillover Effects : A Critical Supply Assessment for Western Technologies From a Risk Management Perspective

Abstract: This paper explores the relationship between Chinese rare earth metals (REMs) and the industries in the U.S and Europe that heavily rely on them. The study uses the EGARCH(1,1)-ARMA(1,0) process for conditional volatility and incorporates it into VAR(8) framework for forecast error variance decomposition to evaluate the static and dynamic volatility spillovers using daily data from the 2nd of January 2018 to the 3rd of March 2023. The liaison of risk management is also consolidated through the incorporation of Value at Risk and Event Study. Our findings indicate that the volatility interconnectedness between the Chinese REMs market and computer and electronics, electric vehicle, and wind energy industries exhibits relatively low volatility spillover to and from each other. Value at Risk measures suggests complexity in assessing the potential short-term losses for REM equity, leading to difficulties in risk management. Establishing and utilizing a derivatives market could be beneficial for future notice. However, the study also highlights that severe geopolitical risk or conflict could enable extreme levels of financial risk due to the global supply dominance of the Chinese quasi-monopolistic construct and the elements' overall criticality in the sustainable energy transition. The study also highlights the infeasibility of Western nations decoupling themselves from the Chinese REM supply. Various factors such as the pace of advancement in sourcing alternatives, technological advancements, and recycling technology are the main drivers of ineligibility. The forecasted global demand for REMs is also expected to increase significantly, primarily driven by the renewable and sustainable energy transition worldwide, further straining the possibility of independence. Therefore, the pace of advancement of these factors must collectively supersede that of the forecasted demand to mitigate the risk. Keywords: Rare Earth Metals, Interconnectedness, Conditional Volatility, Risk Management, Value at Risk, Event Study.