Tail Events : A New Approach to Understanding Extreme Energy Commodity Prices

This paper shows that extreme energy price changes, located in the 10% tails of the distribution, cluster across energy futures markets during the boom–bust cycle of 2006 to 2012. Using multinominal logit regressions, we find that the coincidence of such tail events cannot be explained solely by common supply and demand fundamentals. Instead, we provide evidence that the transmission of extreme price changes occurs through a financial demand channel. Specifically, changes in the net long position of hedge funds are associated with a significant increase in the probability of coincident large positive and negative returns across energy markets. Evidence that index investments drive tail events is limited. Further, we identify adverse shocks to speculator funding liquidity as determinant of synchronized price drops across energy markets. The likelihood of extreme negative returns in more than one market significantly increases when the TED spread rises