Correlation structure between inflation and oil futures returns: An equilibrium approach
AbstractWe use an equilibrium model of a monetary economy to understand the economics behind the correlation between inflation and oil futures returns. We find that some of the positive correlation found in empirical studies is due to the fact that oil is in the consumption basket; however, this accounts only for a minor part of it. There exist other important sources of correlation related to monetary shocks and output shocks. In particular, we find that the correlation is extremely sensitive to the reaction of the central bank to output shocks, while the reaction to inflation changes is less significant. We estimate our model using maximum likelihood with the following data sets: crude oil futures prices, nominal interest rates, inflation rates and money supply growth rates. Our estimates suggest that the monetary authority overreacts to output shocks by increasing the money supply in a more than necessary amount, generating a significant source of positive correlation. From a practical perspective, We find that it is a good strategy to use as a hedge, the futures whose maturity is closer to the hedging horizon. This is particularly true for short-term hedging.
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Bibliographic InfoArticle provided by Elsevier in its journal Resources Policy.
Volume (Year): 35 (2010)
Issue (Month): 4 (December)
Contact details of provider:
Web page: http://www.elsevier.com/locate/inca/30467
Correlation structure Inflation Futures Hedging Oil Monetary policy;
Other versions of this item:
- Jaime Casassus & Diego Ceballos, 2010. "Correlation Structure between Inflation and Oil Futures Returns: An Equilibrium Approach," Documentos de Trabajo 373, Instituto de Economia. Pontificia Universidad Católica de Chile..
- E31 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Price Level; Inflation; Deflation
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- Q31 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Demand and Supply; Prices
- E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
- E52 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Monetary Policy
- E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
- D - Microeconomics
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