Oil market modelling: A comparative analysis of fundamental and latent factor approaches |
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| Affiliation: | 1. DCU Business School, Dublin City University, Ireland;2. ESC Rennes School of Business, France;3. Queen''s Management School, Queen''s University Belfast, UK;1. The York Management School, University of York, Freboys Lane, Heslington, York YO10 5GD, England;2. Leeds University Business School, Maurice Keyworth Building, University of Leeds, Moorland Road, Leeds LS6 1AN, England;1. Department of Earth and Environment, Boston University, Boston, USA;2. School of Management, Boston University, Boston, USA;3. United Nations Conference on Trade and Development (UNCTAD), Geneva, Switzerland;4. Geneva School of Economics and Management, Switzerland |
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| 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. |
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