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Basis variations and regime shifts in the oil futures market

  • Wai Mun Fong
  • Kim Hock See
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    The conditional volatility of crude oil futures returns is modelled as a regime switching process. The model features transition probabilities that are functions of the basis. Consistent with the theory of storage, in volatile periods, an increase in backwardation is associated with an increase in the likellihood of switching to or remaining in the high-volatility state. Conditional on regimes, GARCH persistence is significantly reduced. Out-of-sample tests show that incorporating regime shifts improves the accuracy of short-term volatility forecasts.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/1351847032000082808
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    Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

    Volume (Year): 9 (2003)
    Issue (Month): 5 ()
    Pages: 499-513

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    Handle: RePEc:taf:eurjfi:v:9:y:2003:i:5:p:499-513
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    1. Ernst R. Berndt & Bronwyn H. Hall & Robert E. Hall & Jerry A. Hausman, 1974. "Estimation and Inference in Nonlinear Structural Models," NBER Chapters, in: Annals of Economic and Social Measurement, Volume 3, number 4, pages 653-665 National Bureau of Economic Research, Inc.
    2. Williams,Jeffrey C. & Wright,Brian D., 2005. "Storage and Commodity Markets," Cambridge Books, Cambridge University Press, number 9780521023399.
    3. Bollen, Nicolas P. B. & Gray, Stephen F. & Whaley, Robert E., 2000. "Regime switching in foreign exchange rates: Evidence from currency option prices," Journal of Econometrics, Elsevier, vol. 94(1-2), pages 239-276.
    4. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333.
    5. Litzenberger, Robert H & Rabinowitz, Nir, 1995. " Backwardation in Oil Futures Markets: Theory and Empirical Evidence," Journal of Finance, American Finance Association, vol. 50(5), pages 1517-45, December.
    6. Bailey, Warren & Chang, K C, 1993. " Macroeconomic Influences and the Variability of the Commodity Futures Basis," Journal of Finance, American Finance Association, vol. 48(2), pages 555-73, June.
    7. Gordon, S.F. & Filardo, A.J., 1993. "Business Cycle Durations," Papers 9328, Laval - Recherche en Politique Economique.
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