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Forecasting Nonlinear Crude Oil Futures Prices

The movements in oil prices are very complex and, therefore, seem to be unpredictable. However, one of the main challenges facing econometric models is to forecast such seemingly unpredictable economic series. Traditional linear structural models have not been promising when used for oil price forecasting. Although linear and nonlinear time series models have performed much better in forecasting oil prices, there is still room for improvement. If the data generating process is nonlinear, applying linear models could result in large forecast errors. Model specification in nonlinear modeling, however, can be very case dependent and time-consuming.In this paper, we model and forecast daily crude oil futures prices from 1983 to 2003, listed in NYMEX, applying ARIMA and GARCH models. We then test for chaos using embedding dimension, BDS(L), Lyapunov exponent, and neural networks tests. Finally, we set up a nonlinear and flexible ANN model to forecast the series. Since the test results indicate that crude oil futures prices follow a complex nonlinear dynamic process, we expect that the ANN model will improve forecasting accuracy. A comparison of the results of the forecasts among different models confirms that this is indeed the case.

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Energy Specializations: Petroleum – Markets and Prices for Crude Oil and Products; Energy Investment and Finance – Trading Strategies and Financial Instruments; Energy Modeling – Forecasting and Market Analysis

JEL Codes:
L13 - Oligopoly and Other Imperfect Markets
G13 - Contingent Pricing; Futures Pricing; option pricing
D4 -

Keywords: Crude oil futures, non linear dynamic, chaos, BDS, Lyapunov exponent, neural networks, forecasting

DOI: 10.5547/ISSN0195-6574-EJ-Vol27-No4-4

Published in Volume 27, Number 4 of The Quarterly Journal of the IAEE's Energy Economics Education Foundation.