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Oil Prices and Informational Frictions: The Time-Varying Impact of Fundamentals and Expectations

Author

Listed:
  • Joseph P. Byrne

    (Department of Accountancy, Economics and Finance, School of Social Sciences, Heriot-Watt University)

  • Marco Lorusso

    (Centre for Energy Economics Research and Policy, Heriot-Watt University)

  • Bing Xu

    (School of Management and Languages G.54 Mary Burton Building Heriot-Watt University Edinburg)

Abstract

This paper accounts for informational frictions when modelling the time-varying relationship between crude oil prices, traditional fundamentals and expectations. Informational frictions force a wedge between oil prices and supply and/or demand shocks, especially during periods of elevated risk aversion and uncertainty. In such a context expectations can be a key driver of oil price movements. We utilize a variety of proxies for forward-looking expectations, including business confidence, consumer confidence and leading indicators. In addition, our paper implements a time-varying parameter approach to account empirically for time-varying informational frictions. Our results illustrate firstly that oil supply shocks played an important role in both the 1970’s and coinciding with the recent shale oil boom. Secondly, demand had a positive impact upon oil prices, especially from the mid-2000’s. Finally, we provide evidence that oil prices respond strongly to expectations but the source of the shock matter: business leaders’ expectations are positively related, while markets’ expectations are not strongly linked to oil prices.

Suggested Citation

  • Joseph P. Byrne & Marco Lorusso & Bing Xu, 2017. "Oil Prices and Informational Frictions: The Time-Varying Impact of Fundamentals and Expectations," CEERP Working Paper Series 006, Centre for Energy Economics Research and Policy, Heriot-Watt University.
    • Handle: RePEc:hwc:wpaper:006
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    1. Krzysztof Drachal, 2018. "Determining Time-Varying Drivers of Spot Oil Price in a Dynamic Model Averaging Framework," Energies, MDPI, vol. 11(5), pages 1-24, May.
    2. Takuji Fueki & Jouchi Nakajima & Shinsuke Ohyama & Yoichiro Tamanyu, 2021. "Identifying oil price shocks and their consequences: The role of expectations in the crude oil market," International Finance, Wiley Blackwell, vol. 24(1), pages 53-76, April.

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    Keywords

    Crude Oil Prices; Informational Frictions; Fundamentals; Expectations; Time-Varying Parameters;
    All these keywords.

    JEL classification:

    • C30 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - General
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • F00 - International Economics - - General - - - General
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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