Interpreting the crude oil price movements: Evidence from the Markov regime switching model

Abstract

Since 2009, global financial crisis has eased gradually and world economy has begun to recover slowly. Meanwhile, both Brent and WTI (West Texas Intermediate) crude oil prices have entered into a new round of increase and volatility, and the abnormal price spreads between them have been identified. Under this circumstance, this paper employs the Markov regime switching model with dynamic autoregressive coefficients to explore the price regimes of Brent and WTI after the financial crisis. Then it analyzes the causes of the abnormal spreads between the two benchmark crude oil prices based on the statistical observations of their typical regime differences. The results show that there are three main regimes in both Brent and WTI crude oil price returns, i.e., sharply downward, slightly downward and sharply upward regimes for Brent whilst sharply downward, relatively stable and sharply upward regimes for WTI. Meanwhile, the typical price regimes of Brent and WTI are the “sharply upward” and “relatively stable” regimes after the financial crisis, respectively. Besides, their different movement regimes in recent years are mainly attributed to their different market fundamental situations and the dynamics in crude oil markets, which also lead to the occurrence of their abnormal price spreads.