Abstract
The primary objective of the paper is to investigate if the 2007–2008 crude oil price shock was caused by speculation or changes in fundamentals. First, the history of crude oil prices and energy trends are presented. By evaluating empirical findings and introducing a representative agent model with perfect foresight, the second part of the paper discusses how the 2007–2008 price shock could have been driven purely by changes in market fundamentals. The last part of the paper takes advantage of the fact that all price innovations enter the unified world market for crude oil from the Dubai-Fateh spot price and the price of WTI far-month futures contract. It does so by utilising DOLS estimation to determine R-values which identifies periods of cointegration breakdown and analysing the direction of causality by applying an error correction model during these periods. The paper concludes that the 2007–2008 boom and bust in prices was instigated by changes in fundamentals which were in turn amplified by hedgers and speculators.
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