Understanding Oil Price Movement: Short versus Long Run Using the Leapfrog Model

Abstract

This article studies oil price movement accounting for the time horizon of the pricing model. Historical data demonstrate that the price of oil jumps from one state (condition) to another, remains stable for some time, and then jumps again to a new state, a phenomenon similar to a “leapfrog.” Motivated by this phenomenon, we present a model that we refer to as “leapfrog” to estimate the probability, price, and duration for each price state in order to predict oil price at a forward time horizon. We find that analyzing oil prices for different time horizons (weekly, monthly, and quarterly) conveys different inferences: the shorter the time horizon, the greater the number of states to which the price (frog) may jump (leap), the shorter the duration in each state, and the smaller the price jump. We also study the co-movement between real economic activity and oil price, and find it varies by time horizon, which has implications for measuring the economic significance of shocks to oil prices. Collectively, oil price movement should be analyzed based on the time horizon of interest.