Market Efficiency of Oil Spot and Futures: A Mean-Variance and Stochastic Dominance Approach

Abstract

This paper examines the market efficiency of oil spot and futures prices by using both mean-variance (MV) and stochastic dominance (SD) approaches. Based on the West Texas Intermediate crude oil data for the sample period 1989-2008, we find no evidence of any MV and SD relationships between oil spot and futures indices. This infers that there is no arbitrage opportunity between these two markets, spot and futures do not dominate one another, investors are indifferent to investing in spot or futures, and the spot and futures oil markets are efficient and rational. The empirical findings are robust to each sub-period before and after the crises for different crises, and also to portfolio diversification.

Management Science, Economics and Finance: A Connection

“…For example, based on West Texas Intermediate crude oil data for the sample period 1989-2008, Lean, McAleer, and Wong [43][44][45] apply both MV and SD tests and find that: (i) there is no arbitrage opportunity between these two markets; (ii) spot and futures do not dominate one another; (iii) investors are indifferent to investing spot or futures; and (iv) spot and futures oil markets are efficient and rational.…”

“…Chan, de Peretti, Qiao, and Wong [45][46][47][48] apply both SD and likelihood ratio tests to examine the efficiency of the UK covered warrants market. Their SD findings suggest that neither covered warrants nor the underlying shares stochastically dominate one other, and that the UK covered warrants market is efficient.…”

Price discovery and risk transfer in the Brent crude oil futures market

“…For example, Foster (1996) examine price discovery in WTI and Brent one-month oil futures contract using the generalised dominance model, and find that the futures price lead spot price in both markets before the Gulf War while the relationship changes with spot price been the price leader after the War. Lean et al (2010) using the stochastic dominance approach show that WTI spot and futures prices at 1, 2, and 3 months make equal contribution to price discovery. Silvério and Szklorenan (2012) using the Kalman filter technique report that WTI futures price lead spot price and its contribution has been increasing in recent years especially between 2003 and 2008, and after 2009. There are few studies that examine price discovery between crude oil futures contracts in the same market and between contracts of different markets.…”

An Examination of Price Discovery and Volatility Spillovers of Crude Oil in Globally Linked Commodity Markets

“…However, studies have also examined the information transmission of oil under different dimensions by linking the oil with metals and stock markets. In this regard, Lean, McAleer, and Wong (2010) examine the market efficiency of oil futures and spot prices prices of WTI by applying both mean-variance (MV) and stochastic dominance (SD) approaches. The study reports no evidence of any MV and SD relationships between examined series.…”

“…In this regard, an important issue that has garnered a great deal of attention of researchers and policy makers is of testing the efficient market behaviour of energy markets particularly the crude oil with respect to their price discovery and volatility spillover potentials (Lean, McAleer and Wong, 2010). In recent years, especially after the global economic crisis of 2008, there have been significant changes in the energy markets worldwide particularly the crude oil.…”