Is Oil a Financial Asset? An Empirical Investigation Spanning the Last Fifteen Years

Università degli Studi di Firenze, Dipartimento di Scienze Economiche Working Paoer No. 12/2009

29 Pages Posted: 3 Nov 2009

See all articles by Giulio Cifarelli

Giulio Cifarelli

DISEI University of Florence

Giovanna Paladino

IntesaSanpaolo; LUISS Economics Department

Date Written: October 2009

Abstract

The growing presence of financial operators in the oil markets has modified oil price dynamics. The diffusion of techniques based on extrapolative expectations – such as feedback trading – leads to departures of prices from their fundamental values and increases their variability. Oil price changes are here associated with changes in stocks, bonds and effective USD exchange rate. The feedback trading mechanism is combined with an ICAPM and provides a model which is then estimated in a CCC GARCH-M framework, both the risk premium and the feedback trading components of the conditional means being nonlinear functions of the system’s conditional variances and covariances. The empirical analysis identifies a structural change in the year 2000. From then on oil returns tend to become more reactive to the remaining assets of the model and feedback trading more pervasive. A comparison is drawn between three and four asset minimum variance portfolios in the two sub-periods, 1992-1999 and 2000-2008. Oil acquires in the second period, besides its standard properties as a physical commodity, the characteristics of a financial asset. Indeed, the trade-off between risk and returns – measured here by the average return per unit of risk index – indicates that in the last decade oil diversifies away the empirical risk of our portfolio.

Keywords: oil price dynamics, feedback trading, multivariate GARCH-M, portfolio allocation

JEL Classification: G11, G12, G18, Q4

Suggested Citation

Cifarelli, Giulio and Paladino, Giovanna, Is Oil a Financial Asset? An Empirical Investigation Spanning the Last Fifteen Years (October 2009). Università degli Studi di Firenze, Dipartimento di Scienze Economiche Working Paoer No. 12/2009. Available at SSRN: https://ssrn.com/abstract=1499099 or http://dx.doi.org/10.2139/ssrn.1499099

Giulio Cifarelli

DISEI University of Florence ( email )

via delle Pandette 9
Florence 50127
Italy

Giovanna Paladino (Contact Author)

IntesaSanpaolo ( email )

Piazza San Carlo
Torino, 10121
Italy

LUISS Economics Department ( email )

Viale di Villa Massimo, 57
Rome, 00161
Italy

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