The Relation Between WTI and Brent Crude Oil Prices: Cointegration, Volatility, and Bias

The main purpose of our thesis is to examine the short term and long term relationship between the spot prices of two crude oil benchmarks, West Intermediate Texas (WTI) crude oil and Brent crude oil. We analyze the daily, weekly, and monthly spot price of WTI and Brent crude oil for the last 30 years in the period starting in May 1986 till May 2016. We start by testing for stationarity and find that the data has one unit root. After that, we test if the prices of WTI and Brent move together with a stable difference between them by applying Johansen, Engle-Granger, and ARDL tests. Then, we test the data for biasness by interpreting the coefficients in the regression equation and GARCH model. The empirical analysis shows that there is high evidence of short term and long term bias. Additionally, we test for volatility and whether good news and bad news affect the prices of WTI and Brent in the same way. We link the results to a tentative theory of production of two firms that produce WTI and Brent crude oils and each act as a monopoly in its product market. We prove the assumptions of the theory to be true and illustrate the results of the tests using it.