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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: