Financial effects of precautionary demand for oil by Renatas Kizys, University of Portsmouth

We maintain that the uncertainty about the future availability of oil (i.e. precautionary demand shock as per Kilian, 2009) is better approximated by unexpected changes in the convenience yield, which reflects the uncertainty about shortfalls of future supply relative to expected demand. To evaluate this, we employ a structural vector autoregression (SVAR) model that is applied to monthly data over the period of 1986-2016. Our models comprise the convenience yield along with the world oil production growth rate, the real oil returns and the global economic activity index. We show that the information content of the convenience yield is dominated by the precautionary demand shock, with a lesser proportion attributable to idiosyncratic oil price shocks. Furthermore, our precautionary demand shock exerts a positive and significant effect on real oil returns. Our research findings further suggest that stock market returns and stock market volatility are affected differently by precautionary demand and idiosyncratic oil price shocks before and after the Great Recession of 2007-2009.