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Regulations and price discovery: oil spot and futures markets

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  • Ashima Goyal

    ()
    (Indira Gandhi Institute of Development Research)

  • Shruti Tripathi

    ()
    (Indira Gandhi Institute of Development Research)

Abstract

In a period of great oil price volatility, the paper assesses the role of expected net demand compared to liquidity and leverage driven expansion in net long positions. We apply time series tests for mutual and across exchange causality, and lead-lag relationships, between crude oil spot and futures prices on two international and one Indian commodity exchange. We also search for short duration bubbles, and how they differ across exchanges. The results show expectations mediated through financial markets did not lead to persistent deviations from fundamentals. There is mutual Granger causality between spot and futures, and in the error correction model for mature exchanges, spot leads futures. Mature market exchanges lead in price discovery. Futures in these markets lead Indian (daily) futures-markets are integrated. But there is stronger evidence of short-term or collapsing bubbles in mature market futures compared to Indian, although mature markets have a higher share of hedging. Indian regulations such as position limits may have mitigated short duration bubbles. It follows leverage due to lax regulation may be responsible for excess volatility. Well-designed regulations can improve market functioning.

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Bibliographic Info

Paper provided by Indira Gandhi Institute of Development Research, Mumbai, India in its series Indira Gandhi Institute of Development Research, Mumbai Working Papers with number 2012-016.

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Length: 31 pages
Date of creation: Mar 2012
Date of revision:
Handle: RePEc:ind:igiwpp:2012-016

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Keywords: crude oil spot; futures; commodity exchanges; short duration bubbles; position limits;

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