Oil market modelling : a comparative analysis of fundamental and latent factor approaches

Cummins, Mark and Dowling, Michael and Kearney, Fearghal (2016) Oil market modelling : a comparative analysis of fundamental and latent factor approaches. International Review of Financial Analysis, 46. pp. 211-218. ISSN 1057-5219 (https://doi.org/10.1016/j.irfa.2016.05.010)

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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.


Cummins, Mark ORCID logoORCID: https://orcid.org/0000-0002-3539-8843, Dowling, Michael and Kearney, Fearghal;