Forecasting oil price movements: Exploiting the information in the futures market

Abstract

Abstract Relying on the cost of carry model, the long‐run relationship between spot and futures prices is investigated and the information implied in these cointegrating relationships is used to forecast out of sample oil spot and futures price movements. To forecast oil price movements, a vector error correction model (VECM) is employed, where the deviations from the long‐run relationships between spot and futures prices constitute the equilibrium error. To evaluate forecasting performance, the random walk model (RWM) is used as a benchmark. It was found that (a) in‐sample, the information in the futures market can explain a sizable portion of oil price movements; and (b) out‐of‐sample, the VECM outperforms the RWM in forecasting price movements of 1‐month futures contracts. © 2008 Wiley Periodicals, Inc. Jrl Fut Mark 28:34–56, 2008