Asset Arbitrage and the Price of Oil

CAMA Working Paper No. 21/2011

22 Pages Posted: 6 Jul 2011

See all articles by Vipin Arora

Vipin Arora

Australian National University (ANU)

Rod Tyers

Australian National University (ANU) - School of Economics; The University of Western Australia - Department of Economics

Date Written: July 2011

Abstract

It is commonly understood that macroeconomic shocks influence commodity prices and that one channel for this is the link between interest rates, expected future asset returns and stockholding. In this paper the link is extended to the petroleum market with the recognition that recorded stocks of oil comprise a small share of annual demand and that the parallel with storable commodities is the decision to produce the oil in the first place, as opposed to holding it in the ground as reserve. Oil reserves are then a key asset in producing countries, which is arbitraged against financial assets. Thus, when the yield on financial assets falls, retaining oil reserves becomes more attractive to producing countries, which then have less incentive to accommodate demand rises, and so the oil price rises. This perspective on oil pricing is modeled in a dynamic multi-region general equilibrium framework in which regional households manage portfolios of assets that include oil reserves. When the model is calibrated to match observed data over two decades, simulation results indicate that asset arbitrage made a large contribution to the high pre-GFC oil price.

Keywords: Oil price, arbitrage, two regions, dynamic model, endogenous, interest rates

JEL Classification: E37, F47, Q43

Suggested Citation

Arora, Vipin and Tyers, Rod, Asset Arbitrage and the Price of Oil (July 2011). CAMA Working Paper No. 21/2011, Available at SSRN: https://ssrn.com/abstract=1878154 or http://dx.doi.org/10.2139/ssrn.1878154

Vipin Arora

Australian National University (ANU) ( email )

Canberra, Australian Capital Territory 2601
Australia

Rod Tyers (Contact Author)

Australian National University (ANU) - School of Economics ( email )

Arndt Building
Australian National University
Canberra, Australian Capital Territory 0200
Australia
61-6-249-5124 (Fax)

The University of Western Australia - Department of Economics ( email )

35 Stirling Highway
Crawley, Western Australia 6009
Australia
61 8 6488 5632 (Phone)

HOME PAGE: http://www.business.uwa.edu.au/school/staff-profiles?type=profile&dn=cn%3DRodney%20Tyers%2Cou%3DEcon

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