Oil price Dynamics and Speculation. A Multivariate Financial Approach

Giulio Cifarelli () and Giovanna Paladino

Working Papers - Economics from Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa

Abstract: This paper assesses empirically whether speculation affects oil price dynamics. The growing presence of financial operators in the oil markets has led to the diffusion of trading techniques based on extrapolative expectations. Strategies of this kind foster feedback trading that may cause large departures of prices from their fundamental values. We investigate this hypothesis using a modified CAPM that follows Shiller (1984) and Sentana and Wadhwani (1992). At first, a univariate GARCH(1,1)-M is estimated assuming that the risk premium is a function of the conditional oil price volatility. The single factor model, however, is outperformed by the multifactor ICAPM (Merton, 1973) which takes into account a larger investment opportunity set. The analysis is then carried out using a trivariate CCC GARCH-M model with complex nonlinear conditional mean equations where oil price dynamics are associated with both stock market and exchange rate behavior. We find strong evidence that oil price shifts are negatively related to stock price and exchange rate changes and that a complex web of time varying first and second order conditional moment interactions affect both the CAPM and feedback trading components of the model. Despite the difficulties, we identify a significant role of speculation in the oil market which is consistent with the observed large daily upward and downward shifts in prices. A clear evidence that it is not a fundamentals-driven market. Thus, from a policy point of view - given the impact of volatile oil prices on global inflation and growth - actions that monitor more effectively speculative activities on commodity markets are to be welcomed.

Keywords: oil price dynamics; feedback trading; speculation; multivariate GARCH-M (search for similar items in EconPapers)
JEL-codes: G11 G12 G18 Q40 (search for similar items in EconPapers)
Pages: 28 pages
Date: 2008
New Economics Papers: this item is included in nep-bec and nep-ene
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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Journal Article: Oil price dynamics and speculation: A multivariate financial approach (2010)
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