Diffusion model for crude oil price dynamics

Abstract

The recent crude oil price fluctuation has added a challenge in the conventional economic development paradigm. The irregularity in crude oil price movements shows that petroleum industry has a long lasting impact on the entire economy. This paper develops diffusion model approach to describe the dynamic behaviour of crude oil prices. The tractability of the model is characterised as solutions of stochastic differential equations (SDEs). The result revealed that the dynamic behaviour of oil prices is an Ornstein-Uhlenbeck equation depicting a mean reversion processes in crude oil prices. The Ornstein-Uhlenbeck process is a diffusion process, and a continuous time analogue of the discrete-time autoregressive process of order one (AR(1)).