Oil price volatility forecasts: What do investors need to know?

Degiannakis, Stavros and Filis, George (2019): Oil price volatility forecasts: What do investors need to know?

Abstract

Contrary to the current practice that mainly considers stand-alone statistical loss functions, the aim of the paper is to assess oil price volatility forecasts based on objective-based evaluation criteria, given that different forecasting models may exhibit superior performance at different applications. To do so, we forecast implied and several intraday volatilities and we evaluate them based on financial decisions for which these forecasts are used. In this study we confine our interest on the use of such forecasts from financial investors. More specifically, we consider four well established trading strategies, which are based on volatility forecasts, namely (i) trading the implied volatility based on the implied volatility forecasts, (ii) trading implied volatility based on intraday volatility forecasts, (iii) trading straddles in the United States Oil Fund ETF and finally (iv) trading the United States Oil Fund ETF based on implied and intraday volatility forecasts. We evaluate the after-cost profitability of each forecasting model for 1-day up to 66-days ahead. Our results convincingly show that our forecasting framework is economically useful, since different models provide superior after-cost profits depending on the economic use of the volatility forecasts. Should investors evaluate the forecasting models based on statistical loss functions, then their financial decisions would be sub-optimal. Thus, we maintain that volatility forecasts should be evaluated based on their economic use, rather than statistical loss functions. Several robustness tests confirm these findings.

• Item Type: MPRA Paper
• Language: English
• Keywords: Volatility forecasting, implied volatility, intraday volatility, WTI crude oil futures, objective-based evaluation criteria.
• Subjects: C - Mathematical and Quantitative Methods > C2 - Single Equation Models ; Single Variables > C22 - Time-Series Models ; Dynamic Quantile Regressions ; Dynamic Treatment Effect Models ; Diffusion Processes; C - Mathematical and Quantitative Methods > C5 - Econometric Modeling > C53 - Forecasting and Prediction Methods ; Simulation Methods; G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G17 - Financial Forecasting and Simulation; Q - Agricultural and Natural Resource Economics ; Environmental and Ecological Economics > Q4 - Energy > Q47 - Energy Forecasting

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