Oil Market Modelling: A Comparative Analysis of Fundamental and Latent Factor Approaches

34 Pages Posted: 31 May 2016

See all articles by Mark Cummins

Mark Cummins

Dublin City University Business School

Michael M. Dowling

ESC Rennes School of Business

Fearghal Kearney

Queen's Management School

Date Written: May 28, 2016

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.

Keywords: oil futures, fundamental models, latent factors, Vuong model comparison

JEL Classification: C32, G13, Q41

Suggested Citation

Cummins, Mark and Dowling, Michael M. and Kearney, Fearghal Joseph, Oil Market Modelling: A Comparative Analysis of Fundamental and Latent Factor Approaches (May 28, 2016). International Review of Financial Analysis, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2786049

Mark Cummins (Contact Author)

Dublin City University Business School ( email )

Dublin 9
Ireland

Michael M. Dowling

ESC Rennes School of Business ( email )

Rue Robert d'arbrissel, 2
Rennes, 35000
France

Fearghal Joseph Kearney

Queen's Management School ( email )

Riddel Hall
Belfast, Northern Ireland BT9 5EE
Northern Ireland

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