A team of Kennedy School professors is trying to determine whether investors can find profits and financial stability in the oil futures market.
A committee sponsored by the K-School's Energy and Environmental Policy Center (EEPC) is studying ways in which investors can hedge their bets by trading in contracts to sell oil at specified prices on future dates.
This investigation forms part of an ongoing research project linking the center to several Japanese organizations. Funding for this study came primarily from a group of Japanese businesses and academic institutions, said Cindy Benedict, spokesman for the EEPC.
The study will determine whether investors should use the futures markets to avoid the risks of wild oil price fluctuations, said Professor Robert Weiner, adjunct research fellow of the EEPC.
Committee members will also consider whether oil futures markets can be useful to governments as means of insuring themselves against oil price jumps, along with more traditional methods such as purchasing and stockpiling oil or keeping strategic petroleum reserves, said Kathryn M. Dominguez, assistant professor of public policy at the K-School.
Dominguez and Weiner will work with Assistant Professor John Strong of William and Mary College, under the guidance of EEPC director Irwin M. Steltzer.
Dominguez will study whether the futures markets anticipate future oil prices and whether they add to volatility in the market, she said.
A second segment of the investigation will concentrate on the differences between the oil futures market and the "forward market."
"The futures market has a centralized exchange, while the forward market is more informal," said Weiner, who heads this portion of the study. "Is one less or more risky than the other?"
Weiner will also investigate whether or not regulation affects the market. While the futures market is heavily regulated, the forward market is completely unregulated, Weiner said.
In a third presentation, Professor Strong will demonstrate how stock and bond investments can be used to offset oil price changes and oil market risk.
"Stock and bond markets are much more established, have more liquidity, and have a longer history," Strong said. "There is a better opportunity to make trades on a regular basis."
All three researchers will investigate the problem faced by foreign countries that wish to invest in the oil market. Since oil is always bought and sold in dollars, foreign countries must second-guess both exchange rate fluctuations and the oil market itself, Dominguez said.
"To form the optimal hedge [against higher prices], one may need to take into account both risks," she said.