Unité mixte de recherche 7235

Modeling ex-ante risk premiums in the oil market

Intervenant : Georges Prat

co-auteur: Remzi Uctum


Using survey-based monthly oil price expectations, we measure ex-ante oil risk premiums for 3- and 12-month horizons over a period of thirty years. We show that these premiums, which are particularly appropriate to analyzing investors’ decision-making, are nearly uncorrelated with the ex-post premiums usually employed in the literature where the expected price is replaced by the ex-post realized price. We consider a simple portfolio choice model from which each risk premium can be expressed as the product of the risk price and the expected variance of oil returns, both of these components depending on time and horizon. A two-horizon model of risk premiums, where the risk prices are represented as stochastic unobservable components and the expected variances as weighted averages of actual and past instantaneous variances, is estimated using the Kalman filter methodology. We find that the representative investor is mostly risk seeking at the short horizon and mostly risk averse at the long horizon. The prevalence of risk-aversion when oil market is bullish and of risk seeking when it is bearish is consistent with the predictions of the prospect theory. A dominant upward sloping term structure of ex-ante oil risk premiums is evidenced over our extended period. Our oil risk prices are shown to depend on economic and oil market-related factors.


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