The Asymmetric Effects of Crude Oil Prices and Exchange Rates on Diesel Prices for 27 European Countries
Many studies have examined the asymmetric effect of US
dollar-denominated crude oil prices on petroleum product prices. The ‘rockets
and feathers’ argument suggests that a crude price increase raises petroleum
product prices more than a corresponding decrease in crude prices lowers
product prices. However, for the countries that do not use the US dollar as a
medium of exchange, petroleum product prices are also affected by the exchange
rates. This paper analysed the asymmetric effects of both US dollar-denominated
crude oil prices and exchange rates on local currency-denominated diesel prices
for 27 European countries in the short run as well as long run. The overall
empirical evidence suggests that, in the short run, diesel prices react more to
crude oil price increases than to a decrease, parallel to the ‘rockets and
feathers’ argument. However, contrary to that argument, the long-run adjustment
is the opposite. As for exchange rate shocks, again the ‘rockets and feathers’
argument holds and diesel prices respond more to exchange rate depreciation
than appreciation in the short and long run.
Petroleum product prices are important because of
their effects on economic performance. Therefore, the effects of petroleum
product prices on economic performance have been investigated in various
studies in the literature. Apart from several determinants such as
transportation cost, rental cost and labour cost, petroleum product prices are
mostly influenced by crude oil prices and exchange rates. Most of the earlier studies
were associated with the ‘rockets and feathers’ hypothesis introduced by Bacon (1991), which posits that petroleum product prices react
faster to rises in crude oil prices than to decreases in prices. Besides crude
oil prices, another factor is the exchange rate pass-through to petroleum
product prices that builds up price asymmetry due to exchange rate changes.
Particularly, the recent volatility in crude oil prices attracts attention to
the price asymmetry commonly seen in retail petroleum product markets. This
study aimed to explore the asymmetric effects of crude oil prices and exchange
rates on diesel prices for 27 European countries over the short and long run.
The ‘rockets and feathers’ hypothesis asserts that
gasoline prices give a faster response to increases in crude oil prices than to
decreases. It is suggested that companies, owing to their market power, are
inclined to raise prices rapidly when faced with cost increases while behaving
sluggishly to adjust their prices downwards in response to cost decreases to
keep profit levels high. Some other possible explanations for the presence of
price asymmetry include inventory adjustment costs, the level of competition at
different stages of the distribution channel, consumer search costs, type of
cost shock (permanent vs. transitory cost shock and long-term vs. short-term
cost shock) and consumer response to changing prices. The existing empirical
literature on asymmetric price adjustment between crude oil and gasoline prices
differs by country, data set, frequency of data, the econometric model used and
findings. Although the ‘rockets and feathers’ phenomenon is supported in
several studies, there are also some mixed results in the literature. For
instance, while Bacon (1991) found evidence for strong and rapid adjustment
of UK gasoline prices to cost changes, Manning
(1991) showed that price
adjustment does not last long. Likewise, various results are observed in the
literature, some of which confirm price asymmetry and some which conclude no
asymmetry or mixed signs of asymmetry.
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