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On modeling fossil fuel prices: geometric Brownian motion vs. variance-gamma process

Author

Listed:
  • Alejandro Mosiño

    (Universidad of Guanajuato)

  • Alejandro Tatsuo Moreno-Okuno

    (Universidad de Guanajuato)

Abstract

It is very common in the literature to assume that fossil fuels prices follow a geometric Brownian motion (GBM) process. However, the GBM is an imperfect process in the sense that it cannot capture correctly the frequent extreme movements in fossil fuel prices caused by the information generated within domestic and international markets. In this paper, we use fossil fuel index data to compare the performance of the GBM, which is based on normal density, with that of the variance-gamma (VG) process, which allows us to capture the skewness and the excess of kurtosis of price returns. We show that the VG process fits the data better than does the GBM, as indicated by several goodness-of-fit tests.

Suggested Citation

  • Alejandro Mosiño & Alejandro Tatsuo Moreno-Okuno, 2018. "On modeling fossil fuel prices: geometric Brownian motion vs. variance-gamma process," Economics Bulletin, AccessEcon, vol. 38(1), pages 509-519.
  • Handle: RePEc:ebl:ecbull:eb-17-00495
    as

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    References listed on IDEAS

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    More about this item

    Keywords

    Fossil fuel index; variance-gamma process; geometric Brownian motion process;
    All these keywords.

    JEL classification:

    • C1 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General
    • G1 - Financial Economics - - General Financial Markets

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