Correlation Structure between Inflation and Oil Futures Returns: An Equilibrium Approach
AbstractWe use a general equilibrium model of a monetary economy to understand the economics behind the correlation between in nation and oil futures returns. Oil is used as both, an input to the production of capital and as a consumption good. We estimate our model using maximum likelihood with the following datasets: crude oil futures prices, nominal interest rates, in nation rates and money supply growth rates. We nd 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 nd that the correlation is extremely sensitive to the reaction of the central bank to output shocks, while the reaction to in nation changes is less signi cant. Our estimates suggest that the monetary authority overreacts to output shocks by increasing the money supply in a more than necessary amount, generating a signi cant source of positive correlation. From a practical perspective, We nd 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 InfoPaper provided by Instituto de Economia. Pontificia Universidad Católica de Chile. in its series Documentos de Trabajo with number 373.
Date of creation: 2010
Date of revision:
Correlation structure; inflation; futures; hedging; oil; monetary policy;
Other versions of this item:
- Casassus, Jaime & Ceballos, Diego & Higuera, Freddy, 2010. "Correlation structure between inflation and oil futures returns: An equilibrium approach," Resources Policy, Elsevier, vol. 35(4), pages 301-310, December.
- 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
- D51 - Microeconomics - - General Equilibrium and Disequilibrium - - - Exchange and Production Economies
This paper has been announced in the following NEP Reports:
- NEP-ALL-2010-09-25 (All new papers)
- NEP-CBA-2010-09-25 (Central Banking)
- NEP-CWA-2010-09-25 (Central & Western Asia)
- NEP-DGE-2010-09-25 (Dynamic General Equilibrium)
- NEP-ENE-2010-09-25 (Energy Economics)
- NEP-MAC-2010-09-25 (Macroeconomics)
- NEP-MON-2010-09-25 (Monetary Economics)
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