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Volatility Forecasting of Crude Oil Market: Which Structural Change Based GARCH Models have Better Performance?

Abstract:
GARCH-type models have been widely used for forecasting crude oil price volatility, but often ignore the structural changes of time series, which may lead to spurious volatility persistence. Therefore, this paper focuses on the smooth and sharp structural changes in crude oil price volatility, i.e., smooth shift and regime switching, respectively, and investigates which structural change based GARCH models have better performance for forecasting crude oil price volatility. The empirical results indicate that, first, the flexible Fourier form (FFF) GARCH-type models considering smooth shift can accurately model structural changes and yield superior fitting and forecasting performance to traditional GARCH-type models. Second, the Markov regime switching (MRS) GARCH model incorporating regime switching exhibits superior fitting performance compared to the single-regime GARCH-type models, but it does not necessarily beat the counterparts for forecasting. Finally, the FFF-GARCH-type models outperform MRS-GARCH for forecasting crude oil price volatility and portfolio performance.

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Keywords: Crude oil market, Volatility forecasting, Structural changes, FFF-GARCH models, MRS-GARCH model

DOI: 10.5547/01956574.44.1.yzha

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Published in Volume 44, Number 1 of the bi-monthly journal of the IAEE's Energy Economics Education Foundation.

 

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