The Secret to forecasting oil prices: Today's Oil Price.

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Commodities are up, oil is extremely volatile, and you want in. Who doesn't? Well, perhaps you should get in, but only if you follow one rule "“ no change.
According to a working paper entitled "What Do We Learn From the Price of Crude Oil Futures?", the most accurate way to forecast future oil prices is to use today's oil price.

The authors, Ron Alquist and Lutz Kilian, economists at Michigan, explored the various different ways of forecasting oil prices: oil futures (an agreement for the seller to deliver a certain amount of oil on a certain future date for a certain price), Consensus Forecast, the futures spread (the percent deviation between of the oil futures price and the oil spot price), and other econometric models.  They found that they all do worse than the no-change method: the current price of oil.

Now the common view expressed by the central banks, policy institutions, and sometimes oil analysts is that oil futures prices are a good predictor of the future price of oil. According to the paper, however, projecting future oil prices at today's price performed better than the average of dozens of professional forecasters. It was 34% more accurate at predicting oil prices in three months' time, and 18% more accurate at predicting prices in a year's time. Pretty surprising when you think about it.

Read more of Diana's daily learnings at WhatIlearnd!

July 25, 2008 - 11:29am
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