Using Market Expectations to Test for Speculative Bubbles in the Crude Oil Market

Abstract

The wide fluctuations of oil prices from 2003 to 2008 have attracted the interest of academics and policymakers. A popular view is that these fluctuations were caused by speculative bubbles due to the increased financialization of oil futures markets. This hypothesis, however, is difficult to examine since the fundamental price of oil is unobservable and, therefore, econometric evidence in favor of bubbles may actually be due to misspecified market fundamentals. In this paper, we extend two recently proposed methodologies for bubble detection that alleviate this problem by using market expectations of future prices. Both methodologies provide no evidence of speculative bubbles.

Mild explosivity in recent crude oil prices

“…given our focus on the purely statistical property of mild explosivity, we need not address or tie down here. In this sense, our approach differs from, say, the approach by Pavlidis et al (2018) which is predicated on assumptions about the existence and nature of speculative bubbles. Secondly, results from applying the PWY/PSY testing strategy can been interpreted differently depending on whether or not the third stage Phillips and Yu (2011), we apply the PSY test to assess whether the degree of nonstationarity in the price series is greater than the degree of non-stationarity in the particular fundamental or proxy variable.…”

“…Recent work that discusses the relationship between oil spot and futures prices includes Wang and Wu (2013); Zhang and Wang (2013); Chen et al (2014); Shrestha (2014); Balcilar et al (2015); Chang and Lee (2015); and Nicolau and Palomba (2015). Pavlidis et al (2017) proffer an approach through which differences between spot and forward (futures) prices are exploitable in a test for periodically collapsing bubbles, which Pavlidis et al (2018) apply to oil prices. This approach obviates the need for fundamentals under assumptions that speculative bubbles in oil exist and the connection posited between spot and futures prices is true.…”

“…A key question is whether a demand fundamental or excess speculation was decisive in the run-up in prices towards their high point in mid-2008 (e.g. Kilian and Murphy, 2014;Singleton, 2014;Pavlidis et al 2018). In the same vein, there is currently no consensus as to whether the mid-2014 to early 2016 price decline had a principal driver among multiple causes.…”

Speculative bubbles in segmented markets: Evidence from Chinese cross-listed stocks

“…As argued by several researchers, model misspecification or omitted variables can lead to false inference in favour of bubbles, rendering direct approaches invalid (Hamilton and Whiteman, 1985;Flood and Garber, 1994;Gürkaynak, 2008). To circumvent this problem, more recent studies have employed indirect approaches that exploit information about market fundamentals incorporated in derivative prices or survey data (Pavlidis et al, 2017(Pavlidis et al, , 2018. These studies show that periodically collapsing bubbles create a wedge between actual realizations of future spot prices and market expectations which, under general conditions, depends solely on the bubble process.…”

Sentiment-Induced Bubbles in the Cryptocurrency Market

“…Alternative bubble tests have been proposed e.g., by Pavlidis et al (2017) based on the gap between spot and futures prices and applied to equities and exchange rates, and Pavlidis et al (2018) using market expectations of futures prices applied to the oil market-see also Kruse and Wegener (2019). With the lack of liquidity in futures prices of cryptocurrencies, it seems difficult to apply these tests to crypto markets today.…”