The Elephant in the Ground: Managing Oil and Sovereign Wealth
AbstractMany oil exporters accumulate large sovereign wealth funds, though their portfolio allocation does not take into account below-ground assets, like oil. Similarly, the above-ground portfolio does not affect the decision to extract oil. This paper shows that subsoil oil wealth should change a country's above-ground asset allocation in two ways. First, the holding of all risky assets is leveraged because there is additional wealth outside the fund. Second, more (less) is invested in financial assets that are negatively (positively) correlated with oil to hedge against the riskiness of subsoil exposure. Furthermore, if marginal oil rents move pro-cyclically with the value of the financial assets in the fund, then oil will be extracted slower than predicted by the standard Hotelling rule. This leaves a buffer of oil to be extracted when both oil prices and asset returns are high. Finally, any unhedged residual volatility must be managed through additional precautionary saving.
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Bibliographic InfoPaper provided by University of Oxford, Department of Economics in its series Economics Series Working Papers with number OxCarre Research Paper 129.
Date of creation: 31 Dec 2013
Date of revision:
oil; portfolio allocation; sovereign wealth fund; optimal extraction;
Other versions of this item:
- Ton van den Bremer & Frederick van der Ploeg & Samuel Wills, 2014. "The Elephant in the Ground: Managing oil and sovereign wealth," OxCarre Working Papers 129, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
- E21 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Consumption; Saving; Wealth
- F65 - International Economics - - Economic Impacts of Globalization - - - Finance
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- O13 - Economic Development, Technological Change, and Growth - - Economic Development - - - Agriculture; Natural Resources; Environment; Other Primary Products
- Q32 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Exhaustible Resources and Economic Development
- Q33 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Nonrenewable Resources and Conservation - - - Resource Booms (Dutch Disease)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-04-11 (All new papers)
- NEP-ENE-2014-04-11 (Energy Economics)
- NEP-GER-2014-04-11 (German Papers)
- NEP-MAC-2014-04-11 (Macroeconomics)
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