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Ambiguity and risk in the oil market

Author

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  • Ayoub, Mahmoud
  • Qadan, Mahmoud

Abstract

The empirical evidence about the risk-return relationship in the oil market is mixed and puzzling. Studies in this domain often treat risk and ambiguity (i.e., uncertainty) as interchangeable concepts without making any clear distinction. Motivated by these discrepancies and the limited knowledge about ambiguity in the oil market, we establish a clear difference between risk and ambiguity to explain future returns. Using state-of-the-art methods and high-frequency data from the oil market for 2006–2022, we estimate the risk and level of ambiguity reflected in the oil market. We test the extent to which oil market participants reflect aversion to or love for ambiguity and risk. Our findings indicate that ambiguity and risk contain different information, and both are included in the pricing of crude oil. In addition, risk positively affects expected oil returns, and aversion to ambiguity has a positive relationship with the expected probability of good news and favorable returns.

Suggested Citation

  • Ayoub, Mahmoud & Qadan, Mahmoud, 2024. "Ambiguity and risk in the oil market," Economic Modelling, Elsevier, vol. 132(C).
    • Handle: RePEc:eee:ecmode:v:132:y:2024:i:c:s0264999324000075
    DOI: 10.1016/j.econmod.2024.106651
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    More about this item

    Keywords

    Ambiguity; Ambiguity aversion; Knightian uncertainty; Risk aversion; Oil prices;
    All these keywords.

    JEL classification:

    • J - Labor and Demographic Economics
    • E - Macroeconomics and Monetary Economics
    • L - Industrial Organization
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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