The role of financial speculation in the energy future markets: A new time-varying coefficient approach

•A time varying coefficient model with GARCH innovation is proposed to analyze the oil futures markets.•A sieve MLE approach is adapted to estimate the parameters simultaneously.•Neither speculative nor hedging motive dominates the markets over the whole sample period.•Speculating behavior significantly affected the sharp increase in the price of crude oil in 2008.

To study whether speculating behavior plays an important role in oil futures markets, this paper proposes a time-varying coefficient version of the model of Llorente, Michaely, Saar, and Wang (2002) and estimates the effect of the speculating behavior using a sieve maximum likelihood estimation method. Using the time-varying coefficient model and the data of crude oil and heating oil futures markets, we find that neither the speculative motive nor the hedging motive dominates the markets over the whole sample period. However, we find that one of the two motives dominates the markets over some subsample periods. More importantly, speculation dominates in both the crude oil and heating oil futures markets around 2008. These empirical findings support the argument that the speculating behavior significantly affected the sharp rise in the price of crude oil in 2008.