Discussion Paper Details

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Title: The Elephant in the Ground: Managing Oil and Sovereign Wealth

Author(s): Ton van den Bremer, Frederick van der Ploeg and Samuel Wills

Publication Date: October 2014

Keyword(s): hedging, leverage, oil, optimal extraction, portfolio allocation and sovereign wealth fund

Programme Area(s): International Macroeconomics

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.

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Bibliographic Reference

van den Bremer, T, van der Ploeg, F and Wills, S. 2014. 'The Elephant in the Ground: Managing Oil and Sovereign Wealth'. London, Centre for Economic Policy Research.