Analysis of real oil prices via trend-cycle decomposition

Abstract

The recent fluctuations in the oil prices have intensified the discussion on the dynamics and causes of real oil price changes. While the long-run component of real oil prices seems to have a stochastic trend, global real economic activity has been thought to generate important changes in real oil prices. Based on this argument, in this paper, we analyze the real oil prices within a trend-cycle decomposition framework, where we impose a stochastic trend and assume the cyclical term to be affected by global economic conditions. We also let the parameters vary over time to see whether shocks to trend and the cycle have changing effects on the real oil prices. As a result, we find that shocks to trend are more persistent recently. In that sense, this paper contributes to the literature by offering an explanation for the increased volatility in oil prices. In addition, we show that global economic activity contributed also to the previous oil price shocks, which were regarded mainly as supply-side driven. (C) 2010 Elsevier Ltd. All rights reserved.