Abstract
The random walk, no-change forecast is a customary benchmark in the literature on forecasting commodity prices. We challenge this custom by examining whether alternative models are more suited for this purpose. Based on a literature review and the results of two out-of-sample forecasting experiments, we draw two conclusions. First, in forecasting nominal commodity prices at shorter horizons, the random walk benchmark should be supplemented by futures-based forecasts. Second, in forecasting real commodity prices, the random walk benchmark should be supplemented, if not substituted, by forecasts from the local projection models. In both cases, the alternative benchmarks deliver forecasts of comparable and, in many cases, of superior accuracy.
Highlights
Commodities play an important role in the global economy, whose 5% share is made up by just the oil and natural gas industry, not to mention the significant contribution of other energy, metal, mineral and agriculture commodities
We start by reviewing the literature that explains the joint dynamics of spot and futures prices, we focus on studies using futures prices in forecasting competitions
The random walk no-change forecast is the most popular benchmark against which other methods used for forecasting commodity prices are evaluated
Summary
Commodities play an important role in the global economy, whose 5% share is made up by just the oil and natural gas industry, not to mention the significant contribution of other energy, metal, mineral and agriculture commodities It is, evident that commodity prices are the key drivers of inflation, economic activity or current account balances. For the above reasons, understanding commodity price dynamics and the ability to formulate reliable forecasts are important to many economic agents They would help in assessing strategic policies or investment decisions with a long-term impact. Instead of searching for the best forecasting method, we ask whether the random walk is a proper benchmark in commodity price forecasting We address this issue by comparing two reasonable alternatives.
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