impact of volatility on crude oil prices in arbitrage

8/14/2019 Impact of Volatility on Crude Oil Prices in Arbitrage

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IMPACT OF VOLATILITY IN


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Need of the studyRecent volatility

Effect on :arbitrage and basis


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Objective

The sole objective to develop a relationshipamongst basis, arbitrage and volatility.


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Hypothesis:We assume that arbitrage, basis and volatility

are interrelated to each other


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Contango = futures price > spot price.

Backwardation = futures price < spot price.


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The level and the sign of basis (i.e.backwardation or contango) is referred to as asignal of the shortage or surplus of the physical

commodity in the market.as the futures contract approaches its maturity

date, the basis gets smaller, since the costs ofstorage are no longer a factor .

At the time of maturity, basis diminishes tozero because spot and futures prices converge.If these price relationships do not hold, thereare possible arbitrage opportunities in the


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Spot future parityFor spot and futures prices to be related, spot-

future parity should exist, which is the essenceof the law of one price in futures markets. Spot-

futures parity implies that stable arbitrageopportunities based on the spot-futuresrelationship are not possible.


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We expect that the spot price of an assetconverges to that of the futures price as thedelivery date of the contract approaches ,

otherwise an arbitrage opportunity exists.


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ARBITRAGEAttempting to profit by exploiting price

differences of identical or similar financialinstruments on different markets or in different

forms. The ideal version is riskless arbitrage


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A positive corelationship as high as 99%

Arbitrage strategy


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The exact nature of this relationship willdepend :

on the nature of the commodity (i.e. storableand non-storable)

its relative importance in the world economy

seasonal factors

market expectations


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If the futures price stays above the spot price,we can buy the asset now and short a futurescontract(i.e. agree to sell the asset later at

the future price). If the futures price staysbelow the spot price, anyone who wants theasset should go long on a futures contract andaccept delivery instead of paying the spot

price. This convergence means the spot pricemay go up(down), the futures price may godown (up), or both


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Granger Causality Model

To test this Causality we will use the GrangerCausality Model to prove the direction ofinfluence. The Granger Causality test assumes

that the information relevant to the predictionof the respective variables is contained solelyin the time series data of these variables.


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Result:

Basis effects volatility

(whether positively/negatively)


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.Corelationship between basis and volatility.

A positive corelationshipas high as 99.68%


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Conclusion

Basis volatility and arbitrage move in sync

The hypothesis holds true

impact of volatility on crude oil prices in arbitrage

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