Forecasting the Oil‐Gasoline Price Relationship: Should We Care About the Rockets and the Feathers?

Abstract

According to the Rockets and Feathers hypothesis (RFH), the transmission mechanism of positive and negative changes in the price of crude oil to the price of gasoline is asymmetric. Although there have been many contributions documenting that downstream prices are more reactive to increases than to decreases in upstream prices, little is known about the forecasting performance of econometric models incorporating asymmetric price transmission from crude oil to gasoline. In this paper we fill this gap by comparing point, sign and probability forecasts from a variety of Asymmetric-ECM (A-ECM) and Threshold Autoregressive ECM (TAR-ECM) specifications against a standard ECM. Forecasts from A-ECM and TAR-ECM subsume the RFH, while the ECM implies symmetric price transmission from crude oil to gasoline. We quantify the forecast accuracy gains due to incorporating the RFH in predictive models for the prices of gasoline and diesel. We show that the RFH is useless for point forecasting, while it can be exploited to produce more accurate sign and probability forecasts. Finally, we highlight that the forecasting performance of the estimated models is time-varying.

Keywords: Asymmetries, Forecast Evaluation, Gasoline, Crude Oil, Rockets and Feathers

JEL Classification: C22, C32, C53, Q40, Q47