Risk Premium in the Era of Shale Oil
53 Pages Posted: 6 Aug 2019
Date Written: April 29, 2019
The boom in the production of shale oil in the United States has triggered a structural transformation of the oil market. We show, both theoretically and empirically, that this process has significant consequences for oil risk premium. We construct a model based on shale producers interacting with financial speculators in the futures market. Compared to conventional oil, shale oil technology is more flexible, but producers have higher risk aversion and face additional costs due to their reliance on external finance. Our model helps to explain the observed pattern of aggregate hedging by US oil companies in the last decade. The empirical analysis shows that the hedging pressure of shale producers has become more important than that of conventional producers in explaining the oil futures risk premium.
Keywords: shale oil, futures, risk premium, hedging, speculation, limits to arbitrage
JEL Classification: G00, G13, G32, Q43
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