Using Futures Prices to Filter Short-term Volatility and Recover a Latent, Long-term Price Series for Oil
AbstractOil prices are very volatile. But much of this volatility seems to reflect short-term, transitory factors that may have little or no influence on the price in the long run. Many major investment decisions should be guided by a model of the long-term price of oil and its dynamics. Data on futures prices can be used to filter out the short-term volatility and recover a time series of the latent, long-term price of oil. We test a leading model known as the 2-factor or short-term, long-term model. While the generated latent price variable is clearly an improvement over the raw spot oil price series, we also find that (1) the generated long-term price series still contains some of the short-term volatility, and (2) a naïve use of a long-maturity futures price as a proxy for the long-term price successfully filters out a large majority of the short-term volatility and so may be convenient alternative to the more cumbersome model.
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Bibliographic InfoPaper provided by Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research in its series Working Papers with number 0605.
Date of creation: Apr 2006
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This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-08-12 (All new papers)
- NEP-ENE-2006-08-12 (Energy Economics)
- NEP-FOR-2006-08-12 (Forecasting)
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