The fundamental and speculative components of the oil spot price: a real option value approach

Claudio Dicembrino and Pasquale Lucio Scandizzo

Abstract

ABSTRACT

This paper investigates the recent evolution of the oil price, with the objective of analyzing the main causes of the unstable path and volatility persistence that have been seen in the international oil market in the last fifteen years. We assume that the oil price comprises two components: one deterministic and one speculative. The first can be defined as the certain component, and refers to the fundamental component given by supply and demand interaction. The other, uncertain, component is given by unclear changes in the price structure, and is assumed to be linked to speculative activity. Through a structural equation model in a linear reduced form, we find that the speculation in the oil market, measured with the real options methodology, can improve the traditional model for explaining the consistent part of oil price fluctuations.