Recent years have seen recurring international financial crises, as well as a tremendous rise in trading and speculation. How are the two related? Are speculators and trading responsible for market volatility? This paper presents a study of the Gulf Crisis of 1990–1991, examining the behavior of the international oil market during a period of unprecedented volatility. The analysis suggests that a combination of political events and market fundamentals, rather than trading, was behind this volatility.
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In contrast to IB, there is an active literature in economics on financial globalization. This literature, however, focuses primarily on measurement of international capital mobility, and integration of LDCs into the international financial system, with attendant increased volatility of capital flows (see the recent survey in Schmukler, 2004). Obstfeld and Taylor (2003) provide historical perspectives on financial globalization.
Dodd (2002) discusses derivatives in the Asian crisis, concluding that ‘Derivatives played a key role in the East Asian financial crisis of 1997… derivatives first made the economy more susceptible to financial crisis and then quickened and deepened the downturn once the crisis began’ (p. 447), but provides no empirical evidence or analysis. Ghysels and Seon (2005) examine the crash of the Korean stock market during the Asian crisis, focusing on the role of index futures trading on the Korean Stock Exchange.
Similarly, Shiller (2000, 2003) claims that equity markets demonstrate ‘massive excess volatility (2003, 14) as a result of the ‘irrational exuberance’ of speculators.
Shenkar (2004, 168) suggests the use of case-study methodology as a research strategy in rejuvenating IB's contributions to knowledge as a field.
Figures exclude intra-FSU trade. The share of petroleum in total trade is closely related to oil prices, and thus can fluctuate greatly from year to year. See International Monetary Fund (various years) for trade data, and Oil and Gas Journal (1995) for petroleum data. Petroleum reached 39% of US imports in 1980, falling to about 5% by the mid-1990s.
See Jones and Kaul (1996) on the impact of oil price shocks on Canada, Japan, the UK, and the USA.
This brief account of the Gulf Crisis focuses on aspects salient to the oil market. General diplomatic, military, political, and economic aspects of the Crisis are widely available in the popular press (e.g., Ridgeway, 1991), and will be touched upon here only insofar as they influenced the market.
Shown are closing prices on the New York Mercantile Exchange for the nearby WTI crude oil futures contract. These prices and spot prices are virtually identical as a result of delivery logistics.
Although NYMEX introduced heating-oil contracts in 1978 and crude-oil contracts in 1983, futures trading was negligible during the Iran shock of 1978–80 and oil price collapse in early 1986.
As in earlier shocks, the behavior of oil prices during the Gulf Crisis generated considerable controversy, but relatively little scholarly research. Foster (1996) compared price adjustment in spot and futures markets. Malliaris and Urrutia (1995) examined the impact on international stock prices. Melick and Thomas (1997) looked at market expectations regarding likely future price behavior. For research on earlier oil shocks, see, for example, Frankel (1958) on the Suez Crisis; Vernon (1976), Verleger (1979, 1982), Badger (1984), and Adelman (1995) on the shocks of the 1970s; and Gately (1986) and Weiner (1994) on the 1986 price collapse.
Many of the experts who submitted testimony to the US Senate hearings on the Gulf Crisis shared this view, as did the senators at the hearings. See US Senate (1991).
The literature refers to such uninformed speculators as ‘noise traders’. See the Spring 1990 issue of the Journal of Economic Perspectives, especially Flood and Hodrick (1990) and Shleifer and Summers (1990).
Decomposition of asset prices into ‘news’ and ‘noise’ was introduced in the FX market by Frenkel (1981). For an assessment of trading rules based on technical analysis in the crude oil futures market, see Dominguez (1991). Shleifer and Summers (1990) and Flood and Hodrick (1990) provide an introduction to the finance literature on noise trading. Herding behavior is surveyed in Devenow and Welch (1996). Evidence on herding in oil futures markets is presented in Weiner (2002).
French and Roll (1986) were the first to use this approach: examining US stock prices over the period 1963–82, they found the variance of daily returns much higher when the stock exchanges were open than over weekends and holidays. Results from a variety of market settings generally support their findings: there is a consensus in the literature that asset-price volatility, at least for the case of stock and currency markets, is substantially greater during periods when trading takes place than during non-trading periods (overnight, weekends, holidays, and business days or parts thereof when the relevant exchange is closed).
Eastern time is 5 h behind GMT; the last Sunday in October through the first Sunday in April, 4 h behind the rest of the year. After-hours electronic trading, which would complicate the analysis, started well after this period.
Business hours in the Gulf vary some by country and season, but government ministries, which are open Saturday through Wednesday, plus a half-day Thursday, close at latest by 3 pm in Iraq, 2 pm in Saudi Arabia, and 1:30 pm in Kuwait. Shops reopen in the early evening after afternoon prayers, but government ministries and banks do not.
If some news reaches traders while the exchange is open, this should not affect the validity of the approach, which depends on the comparison between exchange trading and non-trading hours. Note also that existence of price limits (trading halts when prices move sharply in a single day) on all futures contracts except the nearby will tend to bias comparisons of daytime and nighttime volatility, making the former appear too small, and the latter, too large. To avoid this problem, a list of days on which price limits were reached was obtained from NYMEX. When the closing price on a contract represents a limit move, that contract's day-return and the succeeding night-return were dropped from the calculations. If in addition the limit on that day was reached at the opening price, the contract's preceding night-return was dropped as well.
This paper follows the literature by measuring returns as logarithmic price relatives, rather than literal percentage changes.
The 3-year period following the immediate aftermath was also examined, but the results are nearly identical to the immediate aftermath, and are not reported here.
See Schwartz (1997) on mean reversion, which is typical of commodity prices.
Because the variance is the square of the standard deviation, the ‘variance ratio’ column of the table is obtained by squaring the ratio of the figures in the two columns to the left; for example, (1.80/0.82)2=4.80.
See the discussion and references in Lockwood and Linn (1990), who indicate that, in experiments with various methods of testing for heteroskedasticity, the Brown–Forsythe modified Levene test is ‘among the most powerful and is robust regarding departure of the underlying data from normality.’ This test was the most powerful when the underlying data were generated from leptokurtic distributions. The test statistic is:
where subscripts indexing contracts and time period have been omitted for clarity of presentation, D i, day=∣r i, day–m day∣ is the absolute deviation of the return on day i from the median day-return for the contract and period, D day * is the mean absolute deviation from the median day-return for the period and contract (the night variables are analogous), n=n day + n night is the total number of observations for the contract and period, and D *=(n day D day * + n night D night *)/n is the grand mean absolute deviation. The test statistic F robust is distributed ℱ1,n − 2
I am grateful to an anonymous referee for this point.
OECD countries hold strategic petroleum reserves as part of International Energy Agency membership.
A policy of halting petroleum trading on the NYMEX at the time crude oil prices soared to over $40 per barrel was considered by the CFTC, the US futures regulator (Petroleum Intelligence Weekly, 1990). The finding here echoes that of a 1901 statistical study of the German market shutdown: ‘The conditions existent at Berlin during the suspension of the produce exchange … have not imparted greater stability to … prices if, indeed, they have not exercised a deleterious effect…’ (quoted in Bakken, 1953, 139).
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I thank Mirna Hussein, Régis Veillet, Gulcin Afres, Emidio Checcone, Marissa Martinez, and Wenyi Xu for able research assistance, three anonymous referees of this journal, Departmental Editor Lorraine Eden, William Hogan, Tim Krehbiel, Henry Lee, Michael Lynch, John Peterson, Richard Schmalensee, Stephen Smith, and participants at the annual meetings of the Academy of International Business, the American Economics Association, the Financial Management Association, the Multinational Finance Society, and the South Dakota International Business Conference, as well as the Ninth International Symposium on Petroleum Economics, Québec, the 10th Journées du GREEN, the FRB Atlanta/Georgia State/Virginia Tech Conference on Derivatives and Systemic Risk, and the MIT Seminar on Political Economy of Global Energy for comments, the GW Center for the Study of Globalization and the US Department of Energy for support, and the New York Mercantile Exchange for data. Responsibility for the contents of the paper is solely the author's.
Accepted by Lorraine Eden, Department Editor, 21 December 2004. This paper has been with the author for two revisions.
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Weiner, R. Speculation in international crises: report from the Gulf. J Int Bus Stud 36, 576–587 (2005). https://doi.org/10.1057/palgrave.jibs.8400158
- oil shocks
- market turmoil
- financial crises