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International Oil Market Risk Anticipations and the Cushing Bottleneck: Option-implied Evidence

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  • Marie-Hélène Gagnon
  • Gabriel J. Power

Abstract

This paper studies crude oil market integration and spillovers between Brent and WTI oil indexes over the 2006-2019 period. In addition to prices, we estimate time series of model-free option-implied moments to capture forward-looking market views and anticipations of different risk categories. We describe the WTI-Brent equilibrium relationship in prices and in risk expectations measured by implied volatility, skewness, and kurtosis. Using a fractional cointegration model, we find long memory in the price cointegrating vector and in implied moments, implying that persistence of shocks is an important feature of crude oil markets. The evidence supports a differential in implied volatility but not in prices, and suggests equilibrium fragmentation during the Cushing bottleneck period. Analysis of implied moments reveals that Brent and WTI risk anticipations generally share a common equilibrium. Unlike volatility, asymmetric and tail risks are more locally driven, especially during market disruptions such as the Cushing bottleneck, so there is potential for diversifying extreme risks using both indexes.

Suggested Citation

  • Marie-Hélène Gagnon & Gabriel J. Power, 2020. "International Oil Market Risk Anticipations and the Cushing Bottleneck: Option-implied Evidence," The Energy Journal, , vol. 41(6), pages 255-280, November.
    • Handle: RePEc:sae:enejou:v:41:y:2020:i:6:p:255-280
    DOI: 10.5547/01956574.41.6.mgag
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    References listed on IDEAS

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    3. Christoffersen, Peter, 2011. "Elements of Financial Risk Management," Elsevier Monographs, Elsevier, edition 2, number 9780123744487.
    4. Panigirtzoglou, Nikolaos & Skiadopoulos, George, 2004. "A new approach to modeling the dynamics of implied distributions: Theory and evidence from the S&P 500 options," Journal of Banking & Finance, Elsevier, vol. 28(7), pages 1499-1520, July.
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