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

Listed author(s):
  • Mark Cummins

    (DCU - Dublin City University [Dublin])

  • Michael Dowling

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

  • Fearghal Kearney

    (Queen's University Belfast [Belfast] - Queen's University Belfast)

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: https://hal-esc-rennes.archives-ouvertes.fr/hal-01387596/document
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Paper provided by HAL in its series Post-Print with number hal-01387596.

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Date of creation: Jul 2016
Publication status: Published in International Review of Financial Analysis, Elsevier, 2016, Vol. 46, pp. 211-218. <10.1016/j.irfa.2016.05.010>
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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