Speculative Oil Demand and Crude Oil Price Dynamics: A TVP-VAR Approach

Significant decline in the slope of short-term oil supply and demand curves, along with the meaningful change in the degree of risk aversion in arbitrageurs encouraged us to test the time-varying effects of speculative demand on crude oil price dynamics over the period 1985-2016. Using a time-varying parameter vector autoregressive (TVP-VAR) model – with structural shocks identified by Killian and Murphy (2014) approach – we estimated contemporaneous impulse response of real oil prices and crude oil production to speculative demand shock; Furthermore, we derived short-term price elasticity of oil supply in response to speculative demand shock and short-term price elasticity of demand in use. The results demonstrate that the contemporaneous impact of speculative demand shock on oil production has weakened over the examined period of time. Despite moderately stable impact response of real oil price to speculative shocks, the jumps during the periods of high uncertainty and stronger risk aversion are discernable. Moreover, short-term price elasticity of oil supply in response to speculative demand shock, followed a downward trend in a pattern that was always greater than short-term price elasticity of oil supply in response to flow demand shock. The price elasticity of respective oil demand in use was also decreasing and it was smaller than The price elasticity of oil demand in production over the period. Furthermore, the magnitude of speculative oil demand shock volatility plummeted during 1985-1995, before it became stagnant in the succeeding years.