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Mr. Noureddine Krichene
Crude oil prices have been on a run-up spree in recent years. Their dynamics were characterized by high volatility, high intensity jumps, and strong upward drift, indicating that oil markets were constantly out-of-equilibrium. An explanation of the oil price process in terms of the underlying fundamentals of oil markets and world economy was provided, viewing pressure on oil prices mainly as a result of rigid crude oil supply and an expanding world demand for crude oil. A change in the oil price process parameters would require a change in the underlying fundamentals. Market expectations, extracted from call and put option prices, anticipated no change, in the short term, in the underlying fundamentals. Markets expected oil prices to remain volatile and jumpy, and with higher probabilities, to rise, rather than fall, above the expected mean.
Mr. Noureddine Krichene
Following record low interest rates and fast depreciating U.S. dollar, crude oil prices became under rising pressure and seemed boundless. Oil price process parameters changed drastically in 2003M5-2007M10 toward consistently rising prices. Short-term forecasting would imply persistence of observed trends, as market fundamentals and underlying monetary policies were supportive of these trends. Market expectations derived from option prices anticipated further surge in oil prices and allowed significant probability for right tail events. Given explosive trends in other commodities prices, depreciating currencies, and weakening financial conditions, recent trends in oil prices might not persist further without triggering world economic recession, regressive oil supply, as oil producers became wary about inflation. Restoring stable oil markets, through restraining monetary policy, is essential for durable growth and price stability.
Mr. Noureddine Krichene

demand for oil expanded faster than before. Given rigidities in world oil supply, faster growth of oil demand created excess demand for oil. Given short-term inelasticity of oil demand and supply with respect to prices, any small excess demand for oil would cause large variation in prices. In turn, large price increases would have small negative effect on oil demand. Negative price effect, however, would be quickly dominated by positive income effect, i.e., world economic growth, which kept oil prices under rising pressure. VI. M arket I ncompleteness and E

Mr. Noureddine Krichene

sample period and highly expansionary monetary policies caused demand for crude oil to expand at similar pace. In view of the price inelasticities of oil demand and supply, any small excess demand (supply) would require a large price increase (decrease) to clear oil markets; hence, the observed high intensity of jumps and the strong drive for oil prices to rise. Attention was not only limited to historical dynamics of oil prices, but it was also extended to gauging market expectations regarding future developments in these prices. Based on call and put option prices