Monday, August 25, 2014

On Rockets and Feathers

"Rockets and Feathers" is a term that is often used to describe the (apparent) asymmetric responses of downstream price changes to changes in upstream prices. I believe that the expression was coined by Bacon (1991), and it's been used frequently in the literature in connection with the prices of gasoline and crude oil.

When the price of crude oil falls, does the price of gasoline fall as quickly as it rises when the crude oil price rises? Many studies suggest that the answer is "No". The price goes goes up like a rocket, but it falls like a feather.

There are several explanations for this apparent phenomenon, and a really good analysis of these competing hypotheses is provided by Douglas and Herrera (2010), for example.

This phenomenon was mentioned in my recent post about the paper that I presented at the Joint Statistical Meetings a few weeks ago. Since then, I've received a nice email from Andrea Bastianin, a post-doctoral fellow at the University of Milan. Andrea sent me a paper that he and his co-authors have completed, and that's to appear in Energy Economics.

While dealing with the "Rockets and Feathers" hypothesis in relation to oil and gasoline prices, their paper has an important and novel twist to it- they focus on forecasting performance of models that incorporate asymmetry. Here's the abstract:

"According to the Rockets and Feathers hypothesis (RFH), the transmission mechanism of  positive and negative changes in the price of crude oil to the price of gasoline is asymmetric. Although there have been many contributions documenting that downstream prices are more reactive to increases than to decreases in upstream prices, little is known about the forecasting performance of econometric models incorporating asymmetric price transmission from crude oil to gasoline. In this paper we fill this gap by comparing point, sign and probability forecasts from a variety of Asymmetric-ECM (A-ECM) and Threshold Autoregressive ECM (TAR-ECM) specifications against a standard ECM. Forecasts from A-ECM and TAR-ECM subsume the RFH, while the ECM implies symmetric price transmission from crude oil to gasoline. We quantify the forecast accuracy gains due to incorporating the RFH in predictive models for the prices of gasoline and diesel. We show that, as far as point forecasts are involved, the RFH does not lead to significant improvements, while it can be exploited to produce more accurate sign and probability forecasts. Finally, we highlight that the forecasting performance of the estimated models is time-varying."
(My emphasis added.)

This paper by Andrea and his co-authors is a thoughtfully designed and well executed piece of applied econometrics. It adds considerably to what is already a sizeable literature on this topic, and I commend it to you. The link below won't let you download the full paper unless you subscribe to Energy Economics, but I bet Andrea would be happy to send you a copy of the paper if you ask him!



References


Bacon, R. W., 1991. Rockets and feathers: The asymmetric speed of adjustment of UK retail gasoline prices to cost changes. Energy Economics, 13, 211-218.


Bastianin, A., M. Galeotti, and M. Manera, 2014. Forecasting the oil-gasoline price relationship: Do asymmetries help? Energy Economics, in press.

Douglas, C. and A M. Herrera, 2010. Why are gasoline prices sticky? A test of alternative models of price adjustment. Journal of Applied Econometrics, 25, 903-928.






© 2014, David E. Giles

No comments:

Post a Comment