It's time we focused on the risk premium of the oil markets

New study considers oil volatility's impact on financial markets

It's time we focused on the risk premium of the oil markets
Steve Randall

The recent drone strike on Saudi Arabia’s oil infrastructure has highlighted the fragile link between the global oil markets and economy according to a new study.

A team at the University of Technology Sydney looked at 30 years of data and discovered how deeply integrated crude oil markets have become with financial markets.

"We shouldn't underestimate the importance of geopolitical events in the oil market, as it has the power to impend the stability of our financial world," says University of Technology Sydney Finance researcher Dr Christina Sklibosios Nikitopoulos who led the team which also included Dr Boda Kang from Lacima Group and Finance Professor Marcel Prokopczuk from Leibniz University Hannover.

"On 16 September 2019 the oil market witnessed one of the highest intraday moves, with a 15% increase in Brent oil prices and an 14.7% increase in US WTI oil futures. Oil price spikes are seen as a recession barometer, but it is not just price but also volatility that matters," added Dr Nikitopoulos.

The study notes the stellar rise in the market for oil futures and options which began trading in 1983 and 1986 respectively. Daily trading volume has leapt from 21,997 contracts in 2012 to 1.6 million in 2016 and this week surpassed 2 million.

Dr Nikitopoulos notes the growing interest in oil futures, especially crude oil derivatives, as alternative asset classes to equities and bonds.

"Our study highlighted the importance of risk premiums in this market and revealed that credit spreads play a significant role in determining short-term and medium-term variation in oil futures prices," she says.

Global policy discussions
The research found a strengthening of volatility spill-overs between equity and commodity markets.

"It also supports the notion that oil volatility acts as a recession barometer, and fears about the impact of oil shocks on financial stability are justified," added Dr Nikitopoulos.

She says that global discussions by policy makers should include oil futures volatility rather than it being the domain of OPEC and the US Commodity Futures Trading Commission.

"Crude oil futures volatility plays an important role in the global economy and has significant implications for market participants - from oil producers and institutional investors, to traders and market regulators,” she said.