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A Volatility Method of Crude Oil Dynamics: The Role of Market and Commodity Volatilities in Determining Equilibrium Prices

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  • boughabi, houssam

Abstract

This paper develops a volatility-based framework for crude oil pricing by examining the interaction between financial market volatility and commodity-specific risk. The spot price of oil is modeled as a linear combination of stock market and commodity volatilities, allowing the derivation of equilibrium conditions linking financial and commodity markets. Particular attention is given to the dynamics of the functions (A(t,T)) and (B(t,T)), whose evolution reveals a common trajectory consistent with equilibrium behavior between oil price volatility and underlying commodity risk. The analysis highlights the role of volatility transmission mechanisms in shaping commodity prices and provides a novel perspective on the connection between financial market fluctuations and real economic fundamentals. The findings contribute to the literature on commodity pricing by offering a volatility-driven approach that integrates market expectations and risk dynamics into the valuation of crude oil.

Suggested Citation

  • boughabi, houssam, 2025. "A Volatility Method of Crude Oil Dynamics: The Role of Market and Commodity Volatilities in Determining Equilibrium Prices," MPRA Paper 129471, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:129471
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    References listed on IDEAS

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    1. Olivier J. Blanchard & Jordi Galí, 2007. "The Macroeconomic Effects of Oil Price Shocks: Why Are the 2000s so Different from the 1970s?," NBER Chapters, in: International Dimensions of Monetary Policy, pages 373-421, National Bureau of Economic Research, Inc.
    2. James D. Hamilton, 2009. "Causes and Consequences of the Oil Shock of 2007-08," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 40(1 (Spring), pages 215-283.
    3. Robert S. Pindyck, 2004. "Volatility and commodity price dynamics," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 24(11), pages 1029-1047, November.
    4. Lutz Kilian, 2009. "Not All Oil Price Shocks Are Alike: Disentangling Demand and Supply Shocks in the Crude Oil Market," American Economic Review, American Economic Association, vol. 99(3), pages 1053-1069, June.
    5. R. Cont, 2001. "Empirical properties of asset returns: stylized facts and statistical issues," Quantitative Finance, Taylor & Francis Journals, vol. 1(2), pages 223-236.
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    Keywords

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    JEL classification:

    • C22 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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