Quantifying time-varying forecast uncertainty and risk for the real price of oil

In the new CAMP working paper 03/2021, Aastveit, Cross and van Dijk propose a novel and numerically efficient quantification approach to forecast uncertainty of the real price of oil using a combination of probabilistic individual model forecasts. The combination method extends earlier approaches that have been applied to oil price forecasting, by allowing for sequentially updating of time-varying combination weights, estimation of time-varying forecast biases and facets of miscalibration of individual forecast densities and time-varying inter-dependencies among models. To illustrate the usefulness of the method, the authors present an extensive set of empirical results about time-varying forecast uncertainty and risk for the real price of oil over the period 1974-2018. They show that the combination approach systematically outperforms commonly used benchmark models and combination approaches, both in terms of point and density forecasts. The dynamic patterns of the estimated individual model weights are highly time-varying, reflecting a large time variation in the relative performance of the various individual models. The combination approach has built-in diagnostic information measures about forecast inaccuracy and/or model set incompleteness, which provide clear signals of model incompleteness during three crisis periods. To highlight that the approach also can be useful for policy analysis, they present a basic analysis of profit-loss and hedging against price risk.

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