Modeling crude oil spot price as an Ornstein - Uhlenbeck process

Abstract

Unexpected downturn in crude oil price in recent years has led to recession in economies of countries like Nigeria, and Venezuela. Search for a stochastic model that could give a good description of the movement of crude oil price led to the use of Ornstein Uhlenbeck process, since mean reversion is exhibited by the price of a number of commodities. We consider crude oil price series for four Niger-Delta crude types, over a five year period, and analyse same using the Ornstein-Uhlenbeck process. Parameters of the Ornstein-Uhlenbeck process were estimated for the data set using regression approach in R. These parameters were employed to simulate the Ornstein-Uhlenbeck process using an R-computational scheme. In-sample and Out-of-sample forecast were done. It is found that in the absence of the unusual price movements (jumps), the O-U model can be used to model crude oil price movement.