Oil price fluctuation is one of the biggest economic problems facing governments and companies. A price spike can stunt economic growth or blow a hole in government budgets. A price plunge can wreak havoc with cash-strapped companies or trigger wholesale economic reform and shift geopolitical priorities seemingly overnight. The reason for such large swings in the price of crude is complex. It’s a global commodity market, with many different forces pushing prices up and down. A sudden increase in demand can cause a glut, while a slowdown in GDP can push prices down. And in both cases, it can take a while for suppliers to respond.
Technological innovation can also affect oil production, and the availability of natural resources and financial conditions can influence consumer demand. Political events can sway oil prices too, as has been seen in the Iranian revolution, Iran-Iraq war, Arab oil embargo, and numerous other conflicts. In the past, such supply disruptions pushed prices sharply higher and then fell back. In the future, such events may again sway prices.
To get a better understanding of how these factors interact, economists have developed models that can decompose the causes of price fluctuations. In this article, we use a state-space model based on a time-varying structure framework to investigate the dynamic evolution characteristics of oil price fluctuation and its underlying causes. We show that, before the 2008 financial crisis, the impact of crude oil supply and financial fluctuation sources is relatively balanced; however, after the financial crisis, the influence of financial market risks on the fluctuations of crude oil prices becomes much stronger.
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