Examination on the Flow Characteristic of Crude Oil: Evidence from the Risk-Neutral Moments

Abstract

This paper examines the information content of risk-neutral moments to explain crude oil futures returns. Implied volatility and higher moments are extracted from observed crude oil option prices using a model-free implied volatility framework and the Black-Scholes model. We find a tenuous and time-varying association between returns and implied volatility and its innovations. Specifically, changes in implied volatility are found to be meaningfully associated with crude returns only over the period spanning the recent financial crisis. Overall, results are consistent with prior evidence that crude oil prices are determined primarily in a flow demand/supply environment. Finally, we document that oil risk is priced into the cross-section of stock returns in the oil and transportation sectors.

Keywords: Risk-Neutral Moments, Crude Oil Futures, Returns, Volatility

JEL Classification: G13, G14