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ARE PRODUCT SPREADS USEFUL FOR FORECASTING OIL PRICES? AN EMPIRICAL EVALUATION OF THE VERLEGER HYPOTHESIS

Published online by Cambridge University Press:  10 August 2017

Christiane Baumeister ,
Lutz Kilian  and
Xiaoqing Zhou
Christiane Baumeister
Affiliation:
University of Notre Dame
Lutz Kilian*
Affiliation:
University of Michigan
Xiaoqing Zhou
Affiliation:
University of Michigan
*
Address correspondence to: Lutz Kilian, Department of Economics, University of Michigan, 309 Lorch Hall, Ann Arbor, MI 48109-1220, USA; e-mail: lkilian@umich.edu
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Abstract

Many oil industry analysts believe that there is predictive power in the product spread, defined as the difference between suitably weighted refined product market prices and the price of crude oil. We derive a number of alternative forecasting model specifications based on product spreads and compare the implied forecasts to the no-change forecast of the real price of oil. We show that not all product spread models are useful for out-of-sample forecasting, but some models are, even at horizons between one and two years. The most accurate model is a time-varying parameter model of gasoline and heating oil spot price spreads that allows for structural change in product markets. We document mean-squared prediction error reductions as high as 20% and directional accuracy as high as 63% at the two-year horizon, making product spread models a good complement to forecasting models based on economic fundamentals, which work best at short horizons.

Keywords

Oil PriceRefined ProductsCrack SpreadForecast Accuracy
Type
Articles
Information
Macroeconomic Dynamics , Volume 22 , Special Issue 3: Dynamics of Oil and Commodities Prices , April 2018 , pp. 562 - 580
Copyright
Copyright © Cambridge University Press 2017 

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Footnotes

We thank Ron Alquist, Bahattin Büyüksahin, Barbara Rossi, Philip K. Verleger, and Jonathan Wright for helpful comments. Jamshid Mavalwalla provided excellent research assistance.

References

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