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A General Approach to Recovering Market Expectations from Futures Prices with an Application to Crude Oil

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  • Christiane Baumeister
  • Lutz Kilian

Abstract

Futures markets are a potentially valuable source of information about price expectations. Exploiting this information has proved difficult in practice, because time-varying risk premia often render the futures price a poor measure of the market expectation of the price of the underlying asset. Although this expectation in principle may be recovered by adjusting the futures price by the estimated risk premium, a common problem is that there are as many measures of the market expectation as there are estimates of the risk premium. We propose a general solution to this problem that allows us to select the most accurate estimate of the expectation for any set of risk premium estimates. We illustrate this approach by solving the long-standing problem of how to estimate the market expectation of the price of crude oil. We provide a new measure of oil price expectations that is substantially more accurate than the alternatives and more economically plausible. Our analysis has implications for the estimation of economic models of energy-intensive durables, for oil price forecasting, and for the measurement of oil price shocks.

Suggested Citation

  • Christiane Baumeister & Lutz Kilian, 2016. "A General Approach to Recovering Market Expectations from Futures Prices with an Application to Crude Oil," CESifo Working Paper Series 5782, CESifo.
  • Handle: RePEc:ces:ceswps:_5782
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    Cited by:

    1. Sung Je Byun, 2017. "Speculation in Commodity Futures Markets, Inventories and the Price of Crude Oil," The Energy Journal, International Association for Energy Economics, vol. 0(Number 5).
    2. Bielen, David A. & Newell, Richard G. & Pizer, William A., 2018. "Who did the ethanol tax credit benefit? An event analysis of subsidy incidence," Journal of Public Economics, Elsevier, vol. 161(C), pages 1-14.
    3. Konstantinos Gkillas & Rangan Gupta & Mark E. Wohar, 2020. "Oil shocks and volatility jumps," Review of Quantitative Finance and Accounting, Springer, vol. 54(1), pages 247-272, January.
    4. Balcılar, Mehmet & Demirer, Rıza & Hammoudeh, Shawkat, 2015. "Regional and global spillovers and diversification opportunities in the GCC equity sectors," Emerging Markets Review, Elsevier, vol. 24(C), pages 160-187.
    5. Gonzalo Cortazar & Cristobal Millard & Hector Ortega & Eduardo S. Schwartz, 2019. "Commodity Price Forecasts, Futures Prices, and Pricing Models," Management Science, INFORMS, vol. 65(9), pages 4141-4155, September.
    6. Ms. Natasha X Che & Mr. Sebastian Acevedo Mejia & Ke Wang & Ahmed El-Ashram & Julien Reynaud & Arnold McIntyre & Marcio Ronci & Mr. Mark Scott Lutz, 2016. "Caribbean Energy: Macro-Related Challenges," IMF Working Papers 2016/053, International Monetary Fund.
    7. Huang, Shupei & An, Haizhong & Wen, Shaobo & An, Feng, 2017. "Revisiting driving factors of oil price shocks across time scales," Energy, Elsevier, vol. 139(C), pages 617-629.
    8. Ziran Li & Dermot J. Hayes & Keri L. Jacobs, 2018. "The weather premium in the U.S. corn market," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 38(3), pages 359-372, March.
    9. Richard G. Newell and Brian C. Prest, 2019. "The Unconventional Oil Supply Boom: Aggregate Price Response from Microdata," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3).
    10. Kruse, Robinson & Wegener, Christoph, 2020. "Time-varying persistence in real oil prices and its determinant," Energy Economics, Elsevier, vol. 85(C).
    11. Christiane Baumeister & Lutz Kilian, 2016. "Understanding the Decline in the Price of Oil since June 2014," Journal of the Association of Environmental and Resource Economists, University of Chicago Press, vol. 3(1), pages 131-158.
    12. Brandt, Michael W. & Gao, Lin, 2019. "Macro fundamentals or geopolitical events? A textual analysis of news events for crude oil," Journal of Empirical Finance, Elsevier, vol. 51(C), pages 64-94.
    13. Efthymios G. Pavlidis & Ivan Paya & David A. Peel, 2018. "Using Market Expectations to Test for Speculative Bubbles in the Crude Oil Market," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(5), pages 833-856, August.
    14. Valenti, Daniele & Manera, Matteo & Sbuelz, Alessandro, 2020. "Interpreting the oil risk premium: Do oil price shocks matter?," Energy Economics, Elsevier, vol. 91(C).
    15. Adams, Zeno & Collot, Solène & Kartsakli, Maria, 2020. "Have commodities become a financial asset? Evidence from ten years of Financialization," Energy Economics, Elsevier, vol. 89(C).
    16. Gambetti, Luca & Moretti, Laura, 2017. "News, Noise and Oil Price Swings," Research Technical Papers 12/RT/17, Central Bank of Ireland.
    17. Ben Zeev, Nadav & Pappa, Evi & Vicondoa, Alejandro, 2017. "Emerging economies business cycles: The role of commodity terms of trade news," Journal of International Economics, Elsevier, vol. 108(C), pages 368-376.
    18. De Rezende, Rafael B., 2017. "The interest rate effects of government bond purchases away from the lower bound," Journal of International Money and Finance, Elsevier, vol. 74(C), pages 165-186.
    19. Jorge Toro & Aarón Garavito & David Camilo López & Enrique Montes, 2015. "El choque petrolero y sus implicaciones en la economía colombiana," BORRADORES DE ECONOMIA 013829, BANCO DE LA REPÚBLICA.
    20. Reinhard Ellwanger, 2017. "On the Tail Risk Premium in the Oil Market," Staff Working Papers 17-46, Bank of Canada.
    21. Jacopo Piana & Daniele Bianchi, 2017. "Expected Spot Prices and the Dynamics of Commodity Risk Premia," 2017 Meeting Papers 1149, Society for Economic Dynamics.
    22. Robert L. Czudaj, 2021. "Heterogeneity of Beliefs and Information Rigidity in the Crude Oil Market: Evidence from Survey Data," Chemnitz Economic Papers 050, Department of Economics, Chemnitz University of Technology, revised Sep 2021.

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    More about this item

    Keywords

    futures; risk premium; market expectation; model uncertainty; forecast; oil price;
    All these keywords.

    JEL classification:

    • C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Prediction Models; Simulation Methods
    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • Q43 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy and the Macroeconomy

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