Giulio Cifarelli

Oil price Dynamics and Speculation. A Multivariate Financial Approach

This paper assesses empirically whether speculation affects oil price dynamics. The growing presence of financial operators in the oil markets has led to the diffusion of trading techniques based on extrapolative expectations. Strategies of this kind foster feedback trading that may cause large departures of prices from their fundamental values. We investigate this hypothesis using a modified CAPM that follows Shiller (1984) and Sentana and Wadhwani (1992). At first, a univariate GARCH(1,1)-M is estimated assuming that the risk premium is a function of the conditional oil price volatility. The single factor model, however, is outperformed by the multifactor ICAPM (Merton, 1973) which takes into account a larger investment opportunity set. The analysis is then carried out using a trivariate CCC GARCH-M model with complex nonlinear conditional mean equations where oil price dynamics are associated with both stock market and exchange rate behavior. We find strong evidence that oil price shifts are negatively related to stock price and exchange rate changes and that a complex web of time varying first and second order conditional moment interactions affect both the CAPM and feedback trading components of the model. Despite the difficulties, we identify a significant role of speculation in the oil market which is consistent with the observed large daily upward and downward shifts in prices. A clear evidence that it is not a fundamentals-driven market. Thus, from a policy point of view - given the impact of volatile oil prices on global inflation and growth - actions that monitor more effectively speculative activities on commodity markets are to be welcomed.

The Impact of the Argentine Default on Volatility Co-Movements in Emerging Bond Markets

This paper analyses the dynamic interrelationship between sovereign bond spreads in ten emerging markets. It investigates the nature of the volatility transmission in secondary bond markets through conditional covariance estimates obtained by orthogonal methods. This approach, which combines PCA with GARCH volatility modelling, filters away idiosyncratic news and focuses on spreads dynamics driven by common factors. We find convincing evidence of co-movements between spread changes; more within than across geographical areas. Conditional covariations increase in periods of turbulence and subsequently subside. The time varying minimum variance artificial portfolios, which are used here for model validation, show that, in spite of systemic risk, international portfolio diversification is still a powerful strategy for risk reduction.

The buffer stock model redux? An analysis of the dynamics of foreign reserve accumulation

Emerging market economies have recently accumulated large stocks of foreign reserves. In this paper we address the question of what are the main factors accounting for reserve holdings in nine developing countries located in Asia and Latin America. Monthly data from January 1985 to May 2006 are used to estimate for each country the long run equilibrium reserve demand, based on the buffer stock model, the short run dynamics governing the process of reserve accumulation (decumulation) and the factors which may influence the speed of adjustment of actual to desired reserves. Cointegration analysis suggests that the buffer stock precautionary model accounts for the optimal reserve demand. The corresponding VECMs are further interpolated, using the permanent and transitory innovations decomposition procedure of Gonzalo and Ng (2001), in order to assess the relative impact of the time series on the convergence to equilibrium after a shock. Finally the (asymmetric) effect on the speed of convergence of positive/negative changes in signal variables - such as the excess reserves of the previous period, relative competitiveness and US monetary stance - is found to be significant, in line with mercantilistic and fear of floating motives for hoarding international reserves.

Exchange Rate Regimes and Reserve Policy on the Periphery: The Italian Lira 1883-1911

The three exchange rate regimes adopted by Italy from 1883 up to the eve of World War I — the gold standard (1883-1893), floating rates (1894-1902), and “gold shadowing” (1903-1911) — produced a puzzling result: formal adherence to the gold standard ended in failure while shadowing the gold standard proved very successful. This paper discusses the main policies underlying Italy’s performance particularly focusing on the strategy of reserve accumulation. It presents a cointegration analysis identifying a distinct co-movement between exchange rate, reserves, and banknotes that holds over the three sub-periods of the sample. Given this long-run relationship, the different performance in each regime is explained by the diversity of policy measures, reflected in the different variables adjusting the system in the various regimes. Italy’s variegated experience during the gold standard provides a valuable lesson about current developments in the international scenario, showing the central role of fundamenals and consistent policies.

The exchange rate crisis of September 1992 and the pricing of Italian financial futures

The futures contracts on long term bonds issued by the Italian Treasury and the futures contracts on Eurolira deposits traded in the LIFFE have reacted in a specular way to the exchange rate crisis of September 1992. The pricing of the Italian Government Bonds (BTP) futures becomes more volatile and seems to be affected by a time‐varying risk premium. The pricing of Eurolira futures becomes more efficient after the crisis and its volatility declines. These results indicate that the credibility crisis of the Italian Government bonds does not spill over to the off‐shore Eurolira assets.

Is Oil a Financial Asset? An Empirical Investigation Spanning the Last Fifteen Years

The growing presence of financial operators in the oil markets has modified oil price dynamics. The diffusion of techniques based on extrapolative expectations – such as feedback trading – leads to departures of prices from their fundamental values and increases their variability. Oil price changes are here associated with changes in stocks, bonds and effective USD exchange rate. The feedback trading mechanism is combined with an ICAPM and provides a model which is then estimated in a CCC GARCH-M framework, both the risk premium and the feedback trading components of the conditional means being nonlinear functions of the system’s conditional variances and covariances. The empirical analysis identifies a structural change in the year 2000. From then on oil returns tend to become more reactive to the remaining assets of the model and feedback trading more pervasive. A comparison is drawn between three and four asset minimum variance portfolios in the two sub-periods, 1992-1999 and 2000-2008. Oil acquires in the second period, besides its standard properties as a physical commodity, the characteristics of a financial asset. Indeed, the trade-off between risk and returns – measured here by the average return per unit of risk index – indicates that in the last decade oil diversifies away the empirical risk of our portfolio.

One Size Does Not Fit All. A Non-Linear Analysis of European Monetary Transmission

This paper investigates the interest rate pass-through in eight European countries analyzing their short-run and long-run monetary transmission mechanisms. We investigate the relationship between the Euribor and the long-run interest rate on loans to non-financial corporations and allow for a mark-up which can be affected by country specific funding conditions and/or stochastic structural breaks. We detect significant differences across countries. Cointegration between the Euribor and the long-term bank loan interest rates holds for Germany, France, and the Netherlands, where banks seem to apply a constant mark-up. In the remaining countries of the sample the long-run pass-through is directly affected by changes in banks’ cost of funding, due to shifts in the spread between domestic and German long-term government bond interest rates. The selection of the country specific ESTAR/LSTAR parameterization of the short-run dynamics detects a high degree of heterogeneity. The transition variables vary from the government bond spreads, in countries which were involved in the European debt crisis via sovereign bond market contagion, to the VXO index and to the Euribor monthly volatility.

Oil Futures Market: A Dynamic Model of Hedging and Speculation

This paper develops a non linear model for oil futures prices which accounts for pressures due to hedging and speculative activities. The corresponding spot market is assumed to maintain a long term equilibrium relationship with the futures prices in line with the presence of an arbitrage led time varying basis. The model combines an error correction relationship for the cash returns and a non linear parameterization of the corresponding futures returns with a bivariate CCC-TGARCH representation of the conditional variances. The dynamic interaction between spot and futures returns in the oil market has been investigated over the 1990–2010 time period. We have found clear evidence of the activity of hedgers and speculators on the futures markets and the role of the latter is far from negligible. Finally, in order to capture the consequences of the growing impact of financial flows on commodity market pricing, a two-state regime switching model for futures returns has been implemented. The empirical findings indicate that hedging and speculative behavior change across the two regimes, which we associate with low and high return volatility, according to a distinctive pattern.

An Assessment of the Theory of Storage: Has the Relationship between Commodity Price Volatility and Market Fundamentals Changed Over Time?

In this paper we investigate the relationship between commodity price volatility and market fundamentals comparing the 1920s with the present decade and focusing on cotton and tin. The theory of storage provides the theoretical reference for the analysis. Our first result is to find that the series have widely different properties which reflect the speedier diffusion of information in the markets today. This emerges both in the order of autocorrelation of the VECMs used to analyze the dynamics of the spot and futures returns and in the structure of the GARCH parameterization. Our second finding is to show that, based on full sample correlations, the theory of storage seems to capture the dynamics of data with the exception of historical tin. Rolling correlations, however, qualify this result and show that dynamic correlation for historical tin largely corroborate the theory of reference while recent inroads of financial agents in commodity markets seem to have affected the cotton market, giving prominence to financial risk factors.

Reserve overstocking in a highly integrated world. New evidence from Asia and Latin America

Monthly data are used to investigate reserves management in eight Asian and Latin American countries. Idiosyncratic explanatory variables enter into co-integration relationships based on a stochastic buffer stock model, where a reserve variability measure is obtained via conditional variance approaches. International factors influence the co-integration residuals (representing the excess demands for reserves), which tend to co-move within and across geographical areas. Principal components analysis is then implemented to associate their common drivers with the US fed fund effective interest rate and real-effective exchange rate. This two-step approach sheds light on some controversial aspects of reserves and exchange rate management, such as ‘fear of floating’ and mercantilist behavior. Our results suggest that the size of recent excess reserve holdings is probably overstated. †Paper presented at the 47th Annual Conference of the Societá Italiana degli Economisti