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Ambiguity and risk in the oil market

Mahmoud Ayoub and Mahmoud Qadan

Economic Modelling, 2024, vol. 132, issue C

Abstract: The empirical evidence about the risk-return relationship in the oil market is mixed and puzzling. Studies in this domain often treat risk and ambiguity (i.e., uncertainty) as interchangeable concepts without making any clear distinction. Motivated by these discrepancies and the limited knowledge about ambiguity in the oil market, we establish a clear difference between risk and ambiguity to explain future returns. Using state-of-the-art methods and high-frequency data from the oil market for 2006–2022, we estimate the risk and level of ambiguity reflected in the oil market. We test the extent to which oil market participants reflect aversion to or love for ambiguity and risk. Our findings indicate that ambiguity and risk contain different information, and both are included in the pricing of crude oil. In addition, risk positively affects expected oil returns, and aversion to ambiguity has a positive relationship with the expected probability of good news and favorable returns.

Keywords: Ambiguity; Ambiguity aversion; Knightian uncertainty; Risk aversion; Oil prices (search for similar items in EconPapers)
JEL-codes: D53 D81 E G11 G12 J L (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:132:y:2024:i:c:s0264999324000075

DOI: 10.1016/j.econmod.2024.106651

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