Determination of Causality in Prices of Crude Oil

Salman Sarwat, Muhammad Kashif, Muhammad Aqil, Farhan Ahmed

Abstract


Price determination through demand and supply forces is the most efficient pricing mechanism. But, these forces should be real rather than artificial. Speculative trade creates artificial market forces, which bounds to disturb real economy. It is argued that the demand and supply forces are primarily driven by speculation rather than fundamentals in the presence of commodity derivatives. The aim of this study is to empirically test this argument through causality analyses. Crude oil and USA has been selected as a typical case. Daily spot prices of west texas intermediate crude oil and future prices from New York Mercantile Exchange from January 2nd, 1986 to March 6th, 2017 has been analyzed. Granger causality test and vector error correction model are applied to find out the causal relationship between spot and futures prices. Results show that causality runs from runs from crude oil futures to spot prices, crude oil is just one of the numerous commodities, which are being speculatively traded through derivatives.

Keywords: Causality Analysis, Crude Oil Pricing, Futures, Spot Prices, Vector Error Correction Model

JEL Classifications: D40, D49, E44, F01

DOI: https://doi.org/10.32479/ijeep.7724


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