By Bernard Ben Sita

Abstract:

I examine the information sequential hypothesis in complementary oil markets. Unlike the underreaction hypothesis suggested as an explanation to the lagged negative oil effect of financial return, a sequential information schedule through crude oil and gasoline provides a differential dynamic in the way oil risk is channeled to financial markets. Not only do I find that the market response to oil volatility risk is contemporaneous, but that crude oil triggers financial risk at the time of information, whereas gasoline effects of financial risk are subsequent to crude oil effects.

Measuring The Oil Risk Effect On Industry Volatility Shocks – Introduction

There is an abundant literature on the transmission of oil risk to stock markets. In this literature, crude oil risk is perceived as the only global oil source of systematic variation of returns of locally-traded financial securities. However, evidence shows that not only gasoline price incorporates crude oil price information, but also market beliefs at large. In line with for instance Borenstein, Cameron, and Gilbert (1997), the observed lags in gasoline price adjustment to crude oil price decreases may be partly due to the existence of several gasoline markets. Since many gasoline prices are generated for a single crude price, the gasoline market aggregates consumers-beliefs about future crude prices, monopolistic gains, consumer search and learning costs, inventories, refinery capacity and taxation policies1. Despite the systematic nature of the determinants of gasoline prices, the current financial economics literature is silent about the complementarity of the gasoline and crude oil markets in pricing financial assets.

Kaufmann and Ullman (2009) ask where do innovations in world prices enter the market? They find that innovations move sequentially from one crude oil spot market (Dubai-Fateh) to other crude oil spot and futures markets, due partly to the trading behavior of speculators. The sequential nature of price movements across crude oil spot and futures markets is much similar to stock price discovery in financial markets, that is a result of the trading behavior of informed and uninformed traders. If crude oil information is segmented, the question to be asked then is how this information is transmitted to financial markets?