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The Role of Financial Speculation in Driving the Price of Crude Oil

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  • Ron Alquist
  • Olivier Gervais

Abstract

Over the past 10 years, financial firms have increased the size of their positions in the oil futures market. At the same time, oil prices have increased dramatically. The conjunction of these developments has led some observers to argue that financial speculation caused the run-up in oil prices. Yet several arguments cast doubt on the validity of this claim. First, although the stock of open futures contracts is many times larger than the flow of oil consumption in the United States, comparing these two statistics is misleading. Stocks are not measured with respect to a specific unit of time but flows are, so the two are not directly comparable. Second, empirical analysis shows that changes in financial firms’ positions do not predict oil-price changes, but that oil-price changes predict changes in positions. Third, the evidence indicates that financial firms’ positions did not cause the market to expect persistent price increases during 2007/08. Other explanations for the increase in oil prices include macroeconomic fundamentals, such as interest rates and increased demand from emerging Asia. Of these two explanations, the one that seems most consistent with the facts explains oil-price fluctuations in terms of large and persistent demand shocks related to growth in global real activity in the presence of supply constraints.

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Bibliographic Info

Paper provided by Bank of Canada in its series Discussion Papers with number 11-6.

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Length: 22 pages
Date of creation: 2011
Date of revision:
Handle: RePEc:bca:bocadp:11-6

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Keywords: International topics;

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References

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  1. Sanders, Dwight R. & Irwin, Scott H. & Merrin, Robert P., 2008. "The Adequacy of Speculation in Agricultural Futures Markets:Too Much of a Good Thing?," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37615, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  2. Alessio Anzuini & Marco J. Lombardi & Patrizio Pagano, 2012. "The impact of monetary policy shocks on commodity prices," Temi di discussione (Economic working papers) 851, Bank of Italy, Economic Research and International Relations Area.
  3. James L. Smith, 2008. "World Oil: Market or Mayhem?," Working Papers 0815, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.
  4. C. Baumeister & G. Peersman, 2010. "Sources of the Volatility Puzzle in the Crude Oil Market," Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium 10/634, Ghent University, Faculty of Economics and Business Administration.
  5. Lutz Kilian & Bruce Hicks, 2013. "Did Unexpectedly Strong Economic Growth Cause the Oil Price Shock of 2003–2008?," Journal of Forecasting, John Wiley & Sons, Ltd., vol. 32(5), pages 385-394, 08.
  6. Fung, William & Hsieh, David A., 2000. "Measuring the market impact of hedge funds," Journal of Empirical Finance, Elsevier, vol. 7(1), pages 1-36, May.
  7. Kilian, Lutz, 2006. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," CEPR Discussion Papers 5994, C.E.P.R. Discussion Papers.
  8. Kilian, Lutz & Murphy, Dan, 2010. "The Role of Inventories and Speculative Trading in the Global Market for Crude Oil," CEPR Discussion Papers 7753, C.E.P.R. Discussion Papers.
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Citations

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Cited by:
  1. Hamilton, James D. & Wu, Jing Cynthia, 2014. "Risk premia in crude oil futures prices," Journal of International Money and Finance, Elsevier, vol. 42(C), pages 9-37.
  2. Matteo Manera & Marcella Nicolini & Ilaria Vignati, 2013. "Futures price volatility in commodities markets: The role of short term vs long term speculation," DEM Working Papers Series 042, University of Pavia, Department of Economics and Management.
  3. Morana, Claudio, 2013. "Oil price dynamics, macro-finance interactions and the role of financial speculation," Journal of Banking & Finance, Elsevier, vol. 37(1), pages 206-226.
  4. Fattouh, Bassam & Kilian, Lutz & Mahadeva, Lavan, 2012. "The Role of Speculation in Oil Markets: What Have We Learned So Far?," CEPR Discussion Papers 8916, C.E.P.R. Discussion Papers.
  5. Li, Yingzi & Fortenbery, T. Randall, 2013. "Do Speculators in Futures Markets Make Cash Markets More Volatile?," 2013 Annual Meeting, August 4-6, 2013, Washington, D.C. 151296, Agricultural and Applied Economics Association.

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