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Oil Volatility and the Option Value of Waiting: An analysis of the G-7

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Abstract

There has recently been considerable interest in the potential adverse effects associated with excessive uncertainty in energy futures markets. Theoretical models of investment under uncertainty predict that increased uncertainty will tend to induce firms to delay production and investment. These models are widely utilized in capital budgeting and production decisions, particularly in the energy sector. There is relatively little empirical evidence, however, on whether such channels have industry-wide effects. Using a sample of G7 countries we examine whether uncertainty about a prominent commodity – oil – affects the time series variation in production in energy intensive industries. Our primary result is consistent with the predictions of real options theory – uncertainty about oil prices has had a negative and significant effect on manufacturing activity in Canada, France, UK and US.

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Bibliographic Info

Paper provided by Department of Economics, University of Macedonia in its series Discussion Paper Series with number 2010_05.

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Date of creation: Apr 2010
Date of revision: Apr 2010
Handle: RePEc:mcd:mcddps:2010_05

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Web page: http://www.uom.gr/index.php?tmima=3

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Keywords: Oil; Volatility; Vector autoregression; Multivariate GARCH-in-Mean VAR;

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  1. Kiseok Lee & Shawn Ni & Ronald A. Ratti, 1995. "Oil Shocks and the Macroeconomy: The Role of Price Variability," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Number 4), pages 39-56.
  2. Bollerslev, Tim, 1986. "Generalized autoregressive conditional heteroskedasticity," Journal of Econometrics, Elsevier, Elsevier, vol. 31(3), pages 307-327, April.
  3. Stilianos Fountas & Menelaos Karanasos, 2002. "Inflation, Output Growth, and Nominal and Real Uncertainty: Empirical Evidence for the G7," Working Papers, National University of Ireland Galway, Department of Economics 0064, National University of Ireland Galway, Department of Economics, revised 2002.
  4. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, Elsevier, vol. 18(1), pages 7-27, March.
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  7. Knut Anton Mork, 1994. "Business Cycles and the Oil Market," The Energy Journal, International Association for Energy Economics, International Association for Energy Economics, vol. 0(Special I), pages 15-38.
  8. Hamilton, James D., 1996. "This is what happened to the oil price-macroeconomy relationship," Journal of Monetary Economics, Elsevier, Elsevier, vol. 38(2), pages 215-220, October.
  9. Peter Ferderer, J., 1996. "Oil price volatility and the macroeconomy," Journal of Macroeconomics, Elsevier, Elsevier, vol. 18(1), pages 1-26.
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  11. Paul R. Bergin & Reuven Glick, 2006. "Global price dispersion: are prices converging or diverging?," Working Paper Series, Federal Reserve Bank of San Francisco 2006-50, Federal Reserve Bank of San Francisco.
  12. James D. Hamilton, 2000. "What is an Oil Shock?," NBER Working Papers 7755, National Bureau of Economic Research, Inc.
  13. Peter E. Kennedy & John Elder, 2001. "F versus t tests for unit roots," Economics Bulletin, AccessEcon, vol. 3(3), pages 1-6.
  14. Sims, Christopher A, 1980. "Macroeconomics and Reality," Econometrica, Econometric Society, Econometric Society, vol. 48(1), pages 1-48, January.
  15. Alberto Moel, 2002. "When Are Real Options Exercised? An Empirical Study of Mine Closings," Review of Financial Studies, Society for Financial Studies, Society for Financial Studies, vol. 15(1), pages 35-64, March.
  16. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
  17. Pagan, Adrian, 1984. "Econometric Issues in the Analysis of Regressions with Generated Regressors," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 25(1), pages 221-47, February.
  18. Mork, Knut Anton, 1989. "Oil and Macroeconomy When Prices Go Up and Down: An Extension of Hamilton's Results," Journal of Political Economy, University of Chicago Press, University of Chicago Press, vol. 97(3), pages 740-44, June.
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Cited by:
  1. Soojin Jo, 2012. "The Effects of Oil Price Uncertainty on the Macroeconomy," Working Papers, Bank of Canada 12-40, Bank of Canada.
  2. Ine Van Robays, 2012. "Macroeconomic Uncertainty and the Impact of Oil Shocks," CESifo Working Paper Series 3937, CESifo Group Munich.

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