Do Financial Investors Destabilize the Oil Price?
40 Pages Posted: 2 Jun 2011
Date Written: May 20, 2011
In this paper, we assess whether and to what extent financial activity in the oil futures markets has contributed to destabilize oil prices in recent years. We define a destabilizing financial shock as a shift in oil prices that is not related to current and expected fundamentals, and thereby distorts efficient pricing in the oil market. Using a structural VAR model identified with sign restrictions, we disentangle this non-fundamental financial shock from fundamental shocks to oil supply and demand to determine their relative importance. We find that financial investors in the futures market can destabilize oil spot prices, although only in the short run. Moreover, financial activity appears to have exacerbated the volatility in the oil market over the past decade, particularly in 2007-2008. However, shocks to oil demand and supply remain the main drivers of oil price swings.
Keywords: oil price, speculation, structural VAR, sign restrictions
JEL Classification: C32, Q41, Q31
Suggested Citation: Suggested Citation