EconPapers    
Economics at your fingertips  
 

On the Tail Risk Premium in the Oil Market

Reinhard Ellwanger

Staff Working Papers from Bank of Canada

Abstract: This paper shows that changes in market participants’ fear of rare events implied by crude oil options contribute to oil price volatility and oil return predictability. Using 25 years of historical data, we document economically large tail risk premia that vary substantially over time and significantly forecast crude oil futures and spot returns. Oil futures prices increase (decrease) in the presence of upside (downside) fears in order to allow for smaller (larger) returns thereafter. This increase (decrease) is amplified for the spot price because of time varying-benefits from holding physical oil inventories that work in the same direction. We also provide support for view that that time variation in the relative importance of oil demand and supply shocks is an important determinant of oil price fluctuations and their interaction with aggregate outcomes. However, the option-implied tail risk premia are not spanned by traditional macroeconomic and oil market uncertainty measures, suggesting that time-varying oil price fears are an additional source of oil price volatility and predictability.

Keywords: Asset Pricing; Econometric and statistical methods; Financial markets (search for similar items in EconPapers)
JEL-codes: C53 C58 D84 E44 G12 G13 Q43 (search for similar items in EconPapers)
Pages: 40 pages
Date: 2017
New Economics Papers: this item is included in nep-ene, nep-for, nep-rmg and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12) Track citations by RSS feed

Downloads: (external link)
https://www.bankofcanada.ca/wp-content/uploads/2017/11/swp2017-46.pdf

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:bca:bocawp:17-46

Access Statistics for this paper

More papers in Staff Working Papers from Bank of Canada 234 Wellington Street, Ottawa, Ontario, K1A 0G9, Canada. Contact information at EDIRC.
Bibliographic data for series maintained by ().

 
Page updated 2023-01-31
Handle: RePEc:bca:bocawp:17-46