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Modeling of Oil Prices

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The paper derives a parsimonious two-component affine diffusion model with one driving Brownian motion to capture the dynamics of oil prices. It can be observed that the oil price behaves in some sense similarly to the US dollar. However, there are also clear differences. To identify these the paper studies the empirical features of an extremely well diversified world stock index, which is a proxy of the numeraire portfolio, in the denomination of the oil price. Using a diversified index in oil price denomination allows us to disentangle the factors driving the oil price. The paper reveals that the volatility of the numeraire portfolio denominated in crude oil, increases at major oil price upward moves. Furthermore, the log-returns of the index in oil price denomination appear to follow a Student-t distribution. These and other stylized empirical properties lead to the proposed tractable diffusion model, which has the normalized numeraire portfolio and market activity as components. An almost exact simulation technique is described, which illustrates the characteristics of the proposed model and con?rms that it matches well the observed stylized empirical facts.

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File URL: http://www.qfrc.uts.edu.au/research/research_papers/rp321.pdf
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Bibliographic Info

Paper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 321.

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Length: 28
Date of creation: 01 Dec 2012
Date of revision:
Handle: RePEc:uts:rpaper:321

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Related research

Keywords: commodities; oil price; numeraire portfolio; market activity; square root processes; benchmark approach;

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  1. Eckhard Platen & Renata Rendek, 2007. "Empirical Evidence on Student-t Log-Returns of Diversified World Stock Indices," Research Paper Series 194, Quantitative Finance Research Centre, University of Technology, Sydney.
  2. Eckhard Platen, 2009. "A Benchmark Approach to Investing and Pricing," Research Paper Series 253, Quantitative Finance Research Centre, University of Technology, Sydney.
  3. Eckhard Platen, 2006. "A Benchmark Approach To Finance," Mathematical Finance, Wiley Blackwell, vol. 16(1), pages 131-151.
  4. Eckhard Platen & Renata Rendek, 2012. "The Affine Nature of Aggregate Wealth Dynamics," Research Paper Series 322, Quantitative Finance Research Centre, University of Technology, Sydney.
  5. Eckhard Platen & Renata Rendek, 2010. "Approximating the Numeraire Portfolio by Naive Diversification," Research Paper Series 281, Quantitative Finance Research Centre, University of Technology, Sydney.
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