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What Insights Do Short-Maturity (7DTE) Return Predictive Regressions Offer about Risk Preferences in the Oil Market?

Author

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  • Gurdip Bakshi

    (Fox School of Business, Temple University, Philadelphia, PA 19122, USA
    These authors contributed equally to this work.)

  • Xiaohui Gao

    (Fox School of Business, Temple University, Philadelphia, PA 19122, USA
    These authors contributed equally to this work.)

  • Zhaowei Zhang

    (Fox School of Business, Temple University, Philadelphia, PA 19122, USA
    These authors contributed equally to this work.)

Abstract

In this study, we investigate the ability of three higher-order risk-neutral return cumulants to predict short maturity (weekly) returns of oil futures. Our data includes weekly West Texas Crude Oil futures options that expire in 7 days (7DTE). Using a model-free approach, we estimate these risk-neutral return cumulants at the beginning of each options expiration cycle. Our results suggest that the third risk-neutral return cumulant consistently predicts the returns of various oil futures (including WTI, Brent, Dubai, Heating Oil, and RBOB Gasoline). We compare our findings with 14 other predictors and offer a theoretical explanation for the negative coefficient observed for the 7DTE third risk-neutral return cumulant. Our theory connects higher-order risk-neutral return cumulants with the risk premiums of oil futures. Furthermore, our quantitative investment strategy favors the predictability of oil futures returns.

Suggested Citation

  • Gurdip Bakshi & Xiaohui Gao & Zhaowei Zhang, 2024. "What Insights Do Short-Maturity (7DTE) Return Predictive Regressions Offer about Risk Preferences in the Oil Market?," Commodities, MDPI, vol. 3(2), pages 1-23, May.
    • Handle: RePEc:gam:jcommo:v:3:y:2024:i:2:p:14-247:d:1403633
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