Price Discovery in Crude Oil Markets: Intraday Volatility Interactions Between Crude Oil Futures and Energy Exchange Traded Funds

Abstract

In this paper, we investigate the integration of financial derivatives with crude oil prices. The novelty of our paper is its focus on the impact of energy related exchange related funds (exchange traded funds [ETFs]) on crude oil prices. In the previous studies this relationship was studied only between equity markets and crude oil markets however, ETFs are now a crucial tool for information dispersion. First, we examine price discovery of crude oil prices by utilizing causality tests. We conclude that price discovery does not flow consistently from the futures to spot markets or vice versa. The causality is mostly bi-directional from futures market to spot markets for crude oil. Coherently, futures market drives energy-based ETFs market however cross market information increases the explanation power of volatility. Secondly, we tested whether there is any interaction between price volatility, the crude oil prices and energy-based ETF markets by employing EGARCH models using 5-min data. We used three different volatility measures which are square return, Garman and Klass (1980), Rogers and Satchell (1991) and Rogers et al. (1994).

COVID-19 pandemic and financial innovations

“…The second motivation is about the choice of financial innovation as an alternative hedging instrument due to previous findings indicating that traditional instruments have been failing in their hedging role 2 (Sharma and Rodriguez 2019 ; Brim and Wenham 2019 ; Cheema et al 2020 ). Unlike many other conventional investment options, ETFs offer passive and flexible investment strategies that allow investors to hold diversified basket of securities as a single stock rather than separately (Kraft 2012 , Dannhauser 2017 ; Marskz and Lechman 2018 ; Sarkarya and Ekinci 2020 ; Naeem et al 2020 ; Ozdurak and Ulusoy 2020 ; Liu et al 2020 ; Sakarya and Ekinci 2020 ). Further, among financial innovations, exchange-traded funds are one of the most recognized categories of financial innovations with evidence in support of their risk-free nature and portfolio diversification, hence, hedging alternatives, and low correlation with most traditional portfolios, further attesting to their hedging potentials (Cao 1999 ; Asness et al 2001 ; Gao 2001 ; Liang 2001 ; Massa 2002 ; Alexander and Barbosa 2008 ; Tari 2010 ; Madhavan and Maheswaran 2016 ).…”

COVID-19 pandemic and the crude oil market risk: hedging options with non-energy financial innovations

“…More specifically, many studies have discussed the strengths of ETFs as an important financial innovation and alternative investment assets (Agapova 2011 ; Gao 2012 ). More generally, financial innovations possess outstanding qualities; they are flexible investment options that offer risk-averse investors the prospect of holding a diversified basket of assets (although traded as single stocks as found in major global exchanges) without the need to trade in the physical assets defined in conventional investment portfolios (Dannhauser 2017 ; Marskz and Lechman 2018 ; Naeem et al 2020 ; Ozdurak and Ulusoy 2020 ; Sakarya and Ekinci 2020 ).…”

“…We approach the contribution of the study by focusing on financial innovations in non-energy ETFs because we are interested in evaluating the hedging powers for oil price risk. Therefore, the energy components are isolated as the conventional wisdom in the literature; that is, investment assets in the same market/sector are believed to be positively correlated, and therefore, one cannot serve as a good hedge against another because both move in the same direction (see also, El-Sharif et al 2005 ; Naeem et al 2020 ; Ozdurak and Ulusoy 2020 ). For instance, Fig.…”