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

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  • Mark Cummins

    (DCU - Dublin City University [Dublin])

  • Michael Dowling

    (ESC Rennes School of Business - ESC Rennes School of Business)

  • Fearghal Kearney

    (QUB - Queen's University [Belfast])

Abstract

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.

Suggested Citation

  • Mark Cummins & Michael Dowling & Fearghal Kearney, 2016. "Oil market modelling: A comparative analysis of fundamental and latent factor approaches," Post-Print hal-01387596, HAL.
  • Handle: RePEc:hal:journl:hal-01387596 DOI: 10.1016/j.irfa.2016.05.010 Note: View the original document on HAL open archive server: https://hal-esc-rennes.archives-ouvertes.fr/hal-01387596
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    More about this item

    Keywords

    Oil futures; Fundamental models; Latent factors; Vuong model comparison;

    JEL classification:

    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices

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