Estimation and Prediction of Commodity Returns Using Long Memory Volatility Models

Abstract

Modelling the volatility of commodity prices and creating more reliable models for estimating and forecasting commodity price returns are crucial. The body of research on statistical models that can fully reflect the empirical characteristics of commodity price returns is lacking. The main aim of this research was to develop a modelling framework that could be used to accurately estimate and forecast commodity price returns by combining long memory models with heavy-tailed distributions. This study employed dual hybrid long-memory generalised autoregressive conditionally heteroscedasticity (GARCH) models with heavy-tailed innovations, namely, the Student-t distribution (StD), skewed-Student-t distribution (SStD), and the generalised error distribution (GED). Based on the smallest forecasting metrics values for mean absolute error (MAE) and mean squared error (MSE) values, the best performing LM-GARCH-type model for lithium is the ARFIMA (1, o, 1)-FIAPARCH (1, ξ, 1) with normal innovations. For tobacco, the best model is ARFIMA (1, o, 1)-FIGARCH (1, ξ, 1) with SStD innovations. The robust performing model for gold is the ARFIMA (1, o, 1)-FIGARCH (1, ξ, 1)-GED model. The best performing forecasting model for crude oil and cotton returns are the FIAPARCH 1,ξ, 1−SStD model and HYGARCH 1,ξ, 1−StD model, respectively. The results obtained from this study would be beneficial to those concerned with financial market modelling techniques, such as derivative pricing, risk management, asset allocation, and valuation.

Keywords

• dual long memory
• heavy-tailed distribution
• leverage effect
• volatility clustering
• non-negativity