Small Trends and Big Cycles in Crude Oil Prices

Abstract

In this paper, we employ an unobserved components model to disentangle the long-term trend from cyclical movements in international benchmark crude oil prices using data from 1861 to 2010. The in-sample estimation of the model identifies a deterministic quadratic trend and two types of cycles, with the short cycle having a period of 6 years and the long cycle of 29 years. Compared to the large amplitude of the cycles, the growth rate of the long-term trend is small. The out-of-sample forecasting performance of various competing models is compared to that of a “no change” random walk forecast. While the random walk forecast tends to be the most accurate in shorter horizons, it is outperformed by the trend-cycle models in longer horizons. The results provide evidence of predictability in the price of crude oil in longer horizons.

Keywords: oil price, unobserved components model, cycle, trend, forecast

JEL Classification: Q4, C22, N7