Two Essays on Oil Futures Markets

The first chapter of this dissertation estimates the relative contributions of two major exchanges on crude oil futures to the price discovery process-- Chicago Mercantile Exchange (CME) and Intercontinental Exchange (ICE), using trade-by-trade data in 2008. The study also empirically analyzes the effects of trading characteristics on the information share of these two markets. Trading characteristics examined in the study include trading volume, trade size, and trading costs. On average, CME is characterized by greater volume and trade size but also slightly greater bid-ask spread. CME leads the process of price discovery and this leadership is caused by relative trade size and volatility before the financial crisis of 2008; however post-crisis period this leadership is caused by trading volume. Moreover, this study presents evidence that, in times of large uncertainty in the market, the market maker charges a greater bid-ask spread for the more informative market. The second chapter examines the influence of expected oil price volatility, the behavior of the Organization of Petroleum Exporting Countries (OPEC), and the US Dollar exchange rate volatility on the backwardation of crude oil futures during the period from January 1986 to December 2008. The results indicate that oil futures are strongly and weakly backwardated 57% and 69% of the time, respectively. The regression analysis of weak backwardation shows that oil volatility, OPEC overproduction (difference between quota and the actual production), and the volatility of the US Dollar against the Japanese Yen have a positive significant effect on oil backwardation, while OPEC production quota imposed on its members has a negative significant effect on oil backwardation. However the volatility of US Dollar against the British Pound has no significant effect on oil backwardation. The regression analysis of strong backwardation produces qualitatively the same results except that volatility has no effect. In a sub-period analysis, evidence also indicates that trading volume of oil funds and backwardation are negatively related, suggesting that oil funds increase the demand of futures relative to that of spot.