Price Discovery in Crude Oil Prices

Abstract

I examine the relative information roles among West Texas Intermediate spot crude price and four futures contracts (F1 through F4) with different maturities. Using a cointegrated system with a non-unitary cointegrating vector, I address price discovery by investigating which price is more responsive to a common trend shock. With a non-unitary cointegrating vector, it is not clear on how to apply Hasbrouck (1995)'s Information Share (IS) and Yan and Zivot (2007)'s Price Discovery Efficiency Loss (PDEL) measures. I suggest a way to make the IS and PDEL applicable to non-unitary cointegrating vector. Also, I propose a new static price discovery measure, which I call the Adjustment Share (AS). The AS measures the amount of price discovery as the share of contemporaneous adjustment toward the long-run level to a one-unit common trend shock. Applying different price discovery measures to bivariate and 5-variable crude price models I find that F4 and F3 show dominance of price discovery over F2 and F1. If we consider price adjustment to the permanent shock only, F1 does not lead the spot price.