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Are Product Spreads Useful For Forecasting Oil Prices? An Empirical Evaluation Of The Verleger Hypothesis

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  • Baumeister, Christiane
  • Kilian, Lutz
  • Zhou, Xiaoqing

Abstract

Many oil industry analysts believe that there is predictive power in the product spread, defined as the difference between suitably weighted refined product market prices and the price of crude oil. We derive a number of alternative forecasting model specifications based on product spreads and compare the implied forecasts to the no-change forecast of the real price of oil. We show that not all product spread models are useful for out-of-sample forecasting, but some models are, even at horizons between one and two years. The most accurate model is a time-varying parameter model of gasoline and heating oil spot price spreads that allows for structural change in product markets. We document mean-squared prediction error reductions as high as 20% and directional accuracy as high as 63% at the two-year horizon, making product spread models a good complement to forecasting models based on economic fundamentals, which work best at short horizons.

Suggested Citation

  • Baumeister, Christiane & Kilian, Lutz & Zhou, Xiaoqing, 2018. "Are Product Spreads Useful For Forecasting Oil Prices? An Empirical Evaluation Of The Verleger Hypothesis," Macroeconomic Dynamics, Cambridge University Press, vol. 22(3), pages 562-580, April.
  • Handle: RePEc:cup:macdyn:v:22:y:2018:i:03:p:562-580_00
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    Cited by:

    1. Wang, Yudong & Liu, Li & Wu, Chongfeng, 2020. "Forecasting commodity prices out-of-sample: Can technical indicators help?," International Journal of Forecasting, Elsevier, vol. 36(2), pages 666-683.
    2. Baumeister, Christiane & Kilian, Lutz & Lee, Thomas K., 2014. "Are there gains from pooling real-time oil price forecasts?," Energy Economics, Elsevier, vol. 46(S1), pages 33-43.
    3. Christiane Baumeister & Lutz Kilian & Thomas K. Lee, 2017. "Inside the Crystal Ball: New Approaches to Predicting the Gasoline Price at the Pump," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 32(2), pages 275-295, March.
    4. Ederington, Louis H. & Fernando, Chitru S. & Hoelscher, Seth A. & Lee, Thomas K. & Linn, Scott C., 2019. "A review of the evidence on the relation between crude oil prices and petroleum product prices," Journal of Commodity Markets, Elsevier, vol. 13(C), pages 1-15.
    5. Anthony Garratt & Shaun P. Vahey & Yunyi Zhang, 2019. "Real‐time forecast combinations for the oil price," Journal of Applied Econometrics, John Wiley & Sons, Ltd., vol. 34(3), pages 456-462, April.
    6. Doga Bilgin & Reinhard Ellwanger, 2019. "The Simple Economics of Global Fuel Consumption," Staff Working Papers 19-35, Bank of Canada.
    7. Degiannakis, Stavros & Filis, George, 2020. "Oil price assumptions for macroeconomic policy," MPRA Paper 100705, University Library of Munich, Germany.
    8. Dbouk, Wassim & Jamali, Ibrahim, 2018. "Predicting daily oil prices: Linear and non-linear models," Research in International Business and Finance, Elsevier, vol. 46(C), pages 149-165.
    9. Mohamad B. Karaki, 2018. "Asymmetries In The Responses Of Regional Job Flows To Oil Price Shocks," Economic Inquiry, Western Economic Association International, vol. 56(3), pages 1827-1845, July.
    10. Hao, Xianfeng & Zhao, Yuyang & Wang, Yudong, 2020. "Forecasting the real prices of crude oil using robust regression models with regularization constraints," Energy Economics, Elsevier, vol. 86(C).
    11. Jochen H. F. Güntner & Katharina Linsbauer, 2018. "The Effects of Oil Supply and Demand Shocks on U.S. Consumer Sentiment," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 50(7), pages 1617-1644, October.
    12. Yin, Libo & Wang, Yang, 2019. "Forecasting the oil prices: What is the role of skewness risk?," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 534(C).
    13. Liu, Li & Wang, Yudong & Yang, Li, 2018. "Predictability of crude oil prices: An investor perspective," Energy Economics, Elsevier, vol. 75(C), pages 193-205.
    14. Lang, Korbinian & Auer, Benjamin R., 2020. "The economic and financial properties of crude oil: A review," The North American Journal of Economics and Finance, Elsevier, vol. 52(C).
    15. Snudden, Stephen, 2018. "Targeted growth rates for long-horizon crude oil price forecasts," International Journal of Forecasting, Elsevier, vol. 34(1), pages 1-16.

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