Oil Price Dynamics and Speculation: A Multivariate Financial Approach

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 fundamentalsdriven 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.

Causality in distribution between European stock markets and commodity prices: using independence test based on the empirical copula

“…Park and Ratti [2008] use a VAR model. Many authors use the family of GARCH models, specifically bivariate GARCH [Cifarelli, Paladino 2010;Arouri, Lahiani, Nguyen 2011;Arouri 2011;Papież, Śmiech 2012], generalised VAR-GARCH [Arouri, Jouini, Nguyen 2012;Mensi et al 2013] and multivariate GARCH (Creti et al (2013) use dynamic conditional correlation (DCC) GARCH).…”

“…Existing studies present different results; some find that there is no significant effect of oil price shocks on stock prices [Cong et al 2008;Hammoudeh, Choi 2006;Mohanty, Nandha, Bota 2010;Maghyereh 2004;Sari, Soytas 2006], others find a significant positive impact of oil prices on stock prices [Narayan, Narayan 2010;Nguyen, Bhatti 2012;Broadstock, Cao, Zhang 2012;Mohanty et al 2011], while still others find a significant negative effect [Aloui, Jammazi 2009;Park, Ratti 2008;Cifarelli, Paladino 2010]. Hence, the evidence from the existing literature on the significance and sign of the impact of oil price changes on stock prices is still inconclusive.…”

Oil market modelling: A comparative analysis of fundamental and latent factor approaches

“…The evidence on the effects of speculation is mixed. In some studies, speculation is shown to have a statistically significant effect on price and volatility in oil markets, particularly in the lead up to the historically high oil prices achieved pre-crisis (Sornette et al, 2009, Kaufmann and Ullman, 2009, Cifarelli and Paladino, 2010, Du et al, 2011. In contrast, Büyüksahin and Harris (2011) find no evidence that non-commercial positions, including hedge fund positions, have a causal effect on oil prices.…”

Forecasting Long-Term Crude Oil Prices Using a Bayesian Model with Informative Priors

“…Among several financial factors, speculative expectation has been indicated as an important determinant of the price for a commodity [18]. Studies have also provided support for the role of speculation in the oil market, especially for its role in the rise of crude oil prices [18,[28][29][30]. However, the role of speculation in causing the significant changes in oil prices is still debatable.…”