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Rational destabilizing speculation, positive feedback trading, and the oil bubble of 2008

  • Tokic, Damir
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    This article examines how the interaction of different participants in the crude oil futures markets affects the crude oil price efficiency. Normally, the commercial market participants, such as oil producers and oil consumers, act as arbitrageurs and ensure that the price of crude oil remains within the fundamental value range. However, institutional investors that invest in crude oil to diversify their portfolios and/or hedge inflation can destabilize the interaction among commercial participants and liquidity-providing speculators. We argue that institutional investors can impose limits to arbitrage, particularly during the financial crisis when the investment demand for commodities is particularly strong. In support, we show that commercials hedgers had significantly reduced their short positions leading to the 2008 oil bubble--they were potentially aggressively offsetting their short hedges. As a result, by essentially engaging in a positive feedback trading, commercial hedgers at least contributed to 'the 2008 oil bubble'. These findings have been mainly overlooked by the existing research.

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    Article provided by Elsevier in its journal Energy Policy.

    Volume (Year): 39 (2011)
    Issue (Month): 4 (April)
    Pages: 2051-2061

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    Handle: RePEc:eee:enepol:v:39:y:2011:i:4:p:2051-2061
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    1. Giulio Cifarelli & Giovanna Paladino, 2008. "Oil price Dynamics and Speculation. A Multivariate Financial Approach," Working Papers - Economics wp2008_15.rdf, Universita' degli Studi di Firenze, Dipartimento di Scienze per l'Economia e l'Impresa.
    2. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1989. "Positive Feedback Investment Strategies and Destabilizing Rational Speculation," NBER Working Papers 2880, National Bureau of Economic Research, Inc.
    3. Reitz, Stefan & Slopek, Ulf Dieter, 2008. "Nonlinear oil price dynamics: a tale of heterogeneous speculators?," Discussion Paper Series 1: Economic Studies 2008,10, Deutsche Bundesbank, Research Centre.
    4. Sanders, Dwight R. & Irwin, Scott H. & Merrin, Robert P., 2008. "The Adequacy of Speculation in Agricultural Futures Markets: Too Much of a Good Thing?," Marketing and Outlook Research Reports 37512, University of Illinois at Urbana-Champaign, Department of Agricultural and Consumer Economics.
    5. Kaufmann, Robert K. & Ullman, Ben, 2009. "Oil prices, speculation, and fundamentals: Interpreting causal relations among spot and futures prices," Energy Economics, Elsevier, vol. 31(4), pages 550-558, July.
    6. Bekiros, Stelios D. & Diks, Cees G.H., 2008. "The relationship between crude oil spot and futures prices: Cointegration, linear and nonlinear causality," Energy Economics, Elsevier, vol. 30(5), pages 2673-2685, September.
    7. Kesicki, Fabian, 2010. "The third oil price surge - What's different this time?," Energy Policy, Elsevier, vol. 38(3), pages 1596-1606, March.
    8. James D. Hamilton, 2008. "Understanding Crude Oil Prices," NBER Working Papers 14492, National Bureau of Economic Research, Inc.
    9. Headey, Derek & Fan, Shenggen, 2008. "Anatomy of a crisis: The causes and consequences of surging food prices," IFPRI discussion papers 831, International Food Policy Research Institute (IFPRI).
    10. Dufour, Alfonso & Engle, Robert F, 1999. "Time and the Price Impact of a Trade," University of California at San Diego, Economics Working Paper Series qt62c0h04j, Department of Economics, UC San Diego.
    11. David Porter & Vernon Smith, 1994. "Stock market bubbles in the laboratory," Applied Mathematical Finance, Taylor & Francis Journals, vol. 1(2), pages 111-128.
    12. Louis K. C. Chan & Jason Karceski & Josef Lakonishok, 2003. "The Level and Persistence of Growth Rates," Journal of Finance, American Finance Association, vol. 58(2), pages 643-684, 04.
    13. Tokic, Damir, 2010. "The 2008 oil bubble: Causes and consequences," Energy Policy, Elsevier, vol. 38(10), pages 6009-6015, October.
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