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Forecasting commodity prices: GARCH, jumps, and mean reversion

By Jean-Thomas Bernard, Lynda Khalaf, Maral Kichian and Sebastien Mcmahon

Abstract

In examining stochastic models for commodity prices, central questions often revolve around time-varying trend, stochastic convenience yield and volatility, and mean reversion. This paper seeks to assess and compare alternative approaches to modelling these effects, with focus on forecast performance. Three specifications are considered: (i) random-walk models with GARCH and normal or Student- t innovations; (ii) Poisson-based jump-diffusion models with GARCH and normal or Student- t innovations; and (iii) mean-reverting models that allow for uncertainty in equilibrium price. Our empirical application makes use of aluminium spot and futures price series at daily and weekly frequencies. Results show: (i) models with stochastic convenience yield outperform all other competing models, and for all forecast horizons; (ii) the use of futures prices does not always yield lower forecast error values compared to the use of spot prices; and (iii) within the class of (G)ARCH random-walk models, no model uniformly dominates the other. Copyright © 2008 John Wiley & Sons, Ltd.

DOI identifier: 10.1002/for.1061
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