This paper discusses a reason for volatility in oil prices. The Organization of Petroleum Exporting Countries’ (OPEC’s) revenues are positively correlated with macroeconomic activity. Being procyclic, volatility would not seem to benefit OPEC. However, using instruments to sort out endogeneity of OPEC’s revenues with respect to macroeconomic activity, volatility originating with oil prices is countercyclical in the U.S. and Europe, and OPEC, therefore, can command a risk premium. The risk premium may incentivize OPEC to destabilize prices, which lowers macroeconomic output because of the asymmetric effects of oil prices on the macroeconomy. While variation in OPEC’s revenues originating with the macroeconomy was positively correlated with the macroeconomy, OPEC’s revenues are extremely insensitive to macroeconomic activity. As a result, in any conventional model of risk, OPEC can also command a risk premium when volatility originates with the macroeconomy.
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I thank Nathan Kubota for constructive criticism. I thank Elizabeth Ferreira for her ongoing support of this research, including many occasions in which she kept me abreast of developments in oil markets that I would have missed. I am grateful that I am someone who can ‘rejoice in his labor, this is a gift of God’ (Ecclesiastes 5:19).
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Vatter, M.H. OPEC’s Risk Premia and Volatility in Oil Prices. Int Adv Econ Res 25, 165–175 (2019). https://doi.org/10.1007/s11294-019-09734-7
- Risk premium
- Crude oil