Is Oil A Financial Asset? An Empirical Investigation Spanning the Last Fifteen Years

Giulio Cifarelli () and Giovanna Paladino

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

Abstract: The growing presence of financial operators in the oil markets has modified oil price dynamics. The diffusion of techniques based on extrapolative expectations – such as feedback trading – leads to departures of prices from their fundamental values and increases their variability. Oil price changes are here associated with changes in stocks, bonds and effective USD exchange rate. The feedback trading mechanism is combined with an ICAPM and provides a model which is then estimated in a CCC GARCH-M framework, both the risk premium and the feedback trading components of the conditional means being nonlinear functions of the system’s conditional variances and covariances. The empirical analysis identifies a structural change in the year 2000. From then on oil returns tend to become more reactive to the remaining assets of the model and feedback trading more pervasive. A comparison is drawn between three and four asset minimum variance portfolios in the two sub-periods, 1992-1999 and 2000-2008. Oil acquires in the second period, besides its standard properties as a physical commodity, the characteristics of a financial asset. Indeed, the trade-off between risk and returns – measured here by the average return per unit of risk index – indicates that in the last decade oil diversifies away the empirical risk of our portfolio.

Keywords: oil price dynamics; oil price dynamics; feedback trading; multivariate GARCH-M; portfolio allocation. (search for similar items in EconPapers)
JEL-codes: G11 G12 G18 Q40 (search for similar items in EconPapers)
Pages: 29 pages
Date: 2009
New Economics Papers: this item is included in nep-ene
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