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Jumps and stochastic volatility in oil prices: Time series evidence

  • Larsson, Karl
  • Nossman, Marcus

In this paper we examine the empirical performance of affine jump diffusion models with stochastic volatility in a time series study of crude oil prices. We compare four different models and estimate them using the Markov Chain Monte Carlo method. The support for a stochastic volatility model including jumps in both prices and volatility is strong and the model clearly outperforms the others in terms of a superior fit to data. Our estimation method allows us to obtain a detailed study of oil prices during two periods of extreme market stress included in our sample; the Gulf war and the recent financial crisis. We also address the economic significance of model choice in two option pricing applications. The implied volatilities generated by the different estimated models are compared and we price a real option to develop an oil field. Our findings indicate that model choice can have a material effect on the option values.

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Article provided by Elsevier in its journal Energy Economics.

Volume (Year): 33 (2011)
Issue (Month): 3 (May)
Pages: 504-514

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Handle: RePEc:eee:eneeco:v:33:y:2011:i:3:p:504-514
Contact details of provider: Web page: http://www.elsevier.com/locate/eneco

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  11. Bates, David S, 1996. "Jumps and Stochastic Volatility: Exchange Rate Processes Implicit in Deutsche Mark Options," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 69-107.
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