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Oil market modelling: A comparative analysis of fundamental and latent factor approaches

Listed author(s):
  • Cummins, Mark
  • Dowling, Michael
  • Kearney, Fearghal

We formally compare fundamental factor and latent factor approaches to oil price modelling. Fundamental modelling has a long history in seeking to understand oil price movements, while latent factor modelling has a more recent and limited history, but has gained popularity in other financial markets. The two approaches, though competing, have not formally been compared as to effectiveness. For a range of short- medium- and long-dated WTI oil futures we test a recently proposed five-factor fundamental model and a Principal Component Analysis latent factor model. Our findings demonstrate that there is no discernible difference between the two techniques in a dynamic setting. We conclude that this infers some advantages in adopting the latent factor approach due to the difficulty in determining a well specified fundamental model.

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File URL: http://www.sciencedirect.com/science/article/pii/S1057521916300850
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Article provided by Elsevier in its journal International Review of Financial Analysis.

Volume (Year): 46 (2016)
Issue (Month): C ()
Pages: 211-218

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Handle: RePEc:eee:finana:v:46:y:2016:i:c:p:211-218
DOI: 10.1016/j.irfa.2016.05.010
Contact details of provider: Web page: http://www.elsevier.com/locate/inca/620166

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