Causality in Crude Oil Prices

The world market of crude oil has three well established benchmarks used for pricing of other crudes: West Texas Intermediate, Europe Brent and Dubai Fateh. The relevance of these are however declining, as the output of the benchmarks is decreasing, and as an increasing share of world crude produced is of worse quality than the benchmarks (pointed out by e.g. Montepeque, 2005). Particularly the segment of medium density, sour crudes is lacking a reliable benchmark. We apply Granger causality tests to study the price dependencies of 32 crude oils empirically. The aim is to establish what crudes are setting the prices and what crudes are just follow the general market trend. The investigation is performed globally as well as for different quality segments, geographical segments and the segments of OPEC and non-OPEC crudes. The results indicate that crude oil price analysts should follow at least four different crudes that are if not benchmarks, at least good price indicators. While the well-established benchmarks WTI and Brent still lead the market, they are not the only crude prices worth paying attention to. In particular, Russian Urals drives global prices in a significant way, and Iran Seri Kerir is a significant price setter within OPEC. Dubai Fateh does not display any significant influence as a price setter. The lack of a reliable benchmark for medium density, sour crudes is thereby confirmed.Granger causality; crude oil; benchmark; West Texas Intermediate; Europe Brent; Dubai Fateh; Russian Urals; Iran Seri Kerir; price dynamics

Causality in Crude Oil Prices

The world market of crude oil has three well established benchmarks used for pricing of other crudes: West Texas Intermediate, Europe Brent and Dubai Fateh. The relevance of these are however declining, as the output of the benchmarks is decreasing, and as an increasing share of world crude produced is of worse quality than the benchmarks (pointed out by e.g. Montepeque, 2005). Particularly the segment of medium density, sour crudes is lacking a reliable benchmark. We apply Granger causality tests to study the price dependencies of 32 crude oils empirically. The aim is to establish what crudes are setting the prices and what crudes are just follow the general market trend. The investigation is performed globally as well as for different quality segments, geographical segments and the segments of OPEC and non-OPEC crudes. The results indicate that crude oil price analysts should follow at least four different crudes that are if not benchmarks, at least good price indicators. While the well-established benchmarks WTI and Brent still lead the market, they are not the only crude prices worth paying attention to. In particular, Russian Urals drives global prices in a significant way, and Iran Seri Kerir is a significant price setter within OPEC. Dubai Fateh does not display any significant influence as a price setter. The lack of a reliable benchmark for medium density, sour crudes is thereby confirmed

Does commonality in illiquidity matter to investors?

This paper investigates whether investors are compensated for taking on commonality risk in equity portfolios. A large literature documents the existence and the causes of commonality in illiquidity, but the implications for investors are less well understood. In a more than fifty year long sample of NYSE stocks, we find that commonality risk carries a return premium of around 2.6 per cent annually. The commonality risk premium is statistically and economically significant, and substantially higher than what is found in previous studies. It is robust when controlling for illiquidity level effects, different investment horizons, as well as variations in illiquidity measurement and systematic illiquidity estimation

Stock portfolio selection with full-scale optimization and differential evolution

Full-Scale Optimization (FSO) is a utility maximization approach to portfolio choice problems that has theoretical appeal but that suffers from computational burden in large scale problems. We apply the heuristic technique differential evolution to solve FSO-type asset selection problems of 97 assets under complex utility functions rendering rough utility search surfaces. We show that this problem is computationally feasible and that solutions retrieved with random starting values are converging to one optimum. Furthermore, the study constitutes the first FSO application to stock portfolio optimization. The results indicate that when investors are loss averse, FSO improves stock portfolio performance compared to Mean Variance (MV) portfolios. This finding widens the scope of applicability of FSO, but it is also stressed that out-of-sample success will always be dependent on the forecasting ability of the input return distributions.

The components of the illiquidity premium: An empirical analysis of U.S. stocks 1927-2010

This paper implements a conditional version of the liquidity adjusted CAPM (LCAPM). The conditional LCAPM allows for a time-varying decomposition of the total illiquidity premium into a level component and three risk components. The estimated average annual total illiquidity premium for US stocks 1927-2010 is 1.74%-2.08%, which is substantially lower than in most previous studies. The contributions from illiquidity level and illiquidity risk are 1.25%-1.28% and 0.46%-0.83%, respectively. Of the three illiquidity risk components, risk related to the hedging of wealth shocks is the most important, while commonality risk is the least important. The illiquidity premia are clearly time-varying, with peaks in downturns and crises, but with no general tendency to decrease over time. The level premium and the risk premium are significantly positively correlated around 0.35; indicating that in periods of turbulence both illiquidity cost and illiquidity risk premia tend to be high