Time-varying risk premiums in petroleum futures prices

This paper uses an ARMAX-ARCH model to estimate the conditional expected returns of petroleum futures prices under time-varying risk. Empirical results suggest that macroeconomic risk factors have significant forecast power in petroleum futures markets. The conditional expected returns for petroleum futures prices are quite large. Results from a small forecasting experiment indicate that the out-of-sample forecasts from an ARMAX-ARCH model generally outperform a random walk for all forecast horizons. Regression-based tests for market timing indicate that the model captures both the correct sign and the correct magnitude. Net trading profits are positive in all cases. (C) 2002 Elsevier Science B.V. All rights reserved.