Working Paper: CEPR ID: DP10188
Authors: Ton van den Bremer; Frederick van der Ploeg; Samuel Wills
Abstract: Oil exporters typically do not consider below-ground assets when allocating their sovereign wealth fund portfolios, and ignore above-ground assets when extracting oil. We present a unified framework for considering both. Subsoil oil should alter a fund?s portfolio through additional leverage and hedging. First-best spending should be a share of total wealth, and any unhedged volatility must be managed by precautionary savings. If oil prices are pro-cyclical, oil should be extracted faster than the Hotelling rule to generate a risk premium on oil wealth. We then discuss how the management of Norway?s fund can practically be improved with our analysis.
Keywords: hedging; leverage; oil; optimal extraction; portfolio allocation; sovereign wealth fund
JEL Codes: E21; F65; G11; G15; O13; Q32; Q33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| oil wealth (L71) | aboveground asset allocation (G11) |
| oil wealth (L71) | consumption (E21) |
| correlation between oil prices and financial assets (G19) | extraction rates (L72) |
| total wealth (D31) | consumption (E21) |