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Sources of the Volatility Puzzle in the Crude Oil Market

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  • C. BAUMEISTER

    ()

  • G. PEERSMAN

    ()

Abstract

A remarkable but unnoticed feature of the crude oil market is that the dramatic rise in oil price volatility over time has been accompanied by a substantial fall in oil production volatility. We investigate the reasons for this opposite evolution of both oil market variables. Our main finding is that the observed volatility puzzle can be rationalized by the fact that the price elasticities of both oil supply and oil demand have decreased considerably over time. This implies that small disturbances on either side of the oil market currently generate large price reactions but only modest quantity adjustments. We further document that the variance of innovations which shift oil demand and supply has even become smaller in the more recent past thereby mitigating oil price fluctuations.

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File URL: http://www.feb.ugent.be/nl/Ondz/wp/Papers/wp_10_634.pdf
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Bibliographic Info

Paper provided by Ghent University, Faculty of Economics and Business Administration in its series Working Papers of Faculty of Economics and Business Administration, Ghent University, Belgium with number 10/634.

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Length: 42 pages
Date of creation: Jan 2010
Date of revision:
Handle: RePEc:rug:rugwps:10/634

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Related research

Keywords: Oil prices; volatility; time variation; price elasticities;

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