Using futures prices to filter short-term volatility and recover a latent, long-term price series for oil
Name
2006-005.pdf
Size
183.94 KB
Format
Adobe PDF
Checksum (MD5)
95afc07eae78766a70d9a452faa0649a
Author(s)
Herce, Miguel Angel
Parsons, John E.
Ready, Robert C.
Date Issued
2006
Publisher
MIT Center for Energy and Environmental Policy Research
Series/Report no.
MIT-CEEPR (Series) ; 06-005WP.
Abstract
Oil prices are very volatile. But much of this volatility seems to reflect short-term,transitory factors that may have little or no influence on the price in the long run. Many major investment decisions should be guided by a model of the long-term price of oil and its dynamics. Data on futures prices can be used to filter out the short-term volatility and recover a time series of the latent, long-term price of oil. We test a leading model known as the 2-factor or short-term, long-term model. While the generated latent price variable is clearly an improvement over the raw spot oil price series, we also find that (1) the generated long-term price series still contains some of the short-term volatility, and (2) a naïve use of a long-maturity futures price as a proxy for the long-term price successfully filters out a large majority of the short-term volatility and so may be convenient alternative to the more cumbersome model.
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