Residual Trading with WTI Futures Using the Four-factor Diebold-Li Method

Absztrakt (kivonat)

Crude oil is an essential material for industrial production and its price is determined by geographical, political and economic factors globally. In the literature much of interest has been paid to understand its price movements. The author analysed the adaptability of the residual trading strategy on WTI futures term structure and investigated whether an additional fourth factor extension to the original Diebold & Li (2006) model can be leveraged in the trading strategy. The present findings confirm that the two residual trading strategies overperformed the benchmark strategies. Moreover, the fourth factor – second type of curvature – adds value to the residual trading strategy on the WTI futures as the four-factor model has the highest Sharpe ratio among the four strategies and its Sharpe ratio is 37% higher than the second best original three-factor Diebold-Li model’s. These results are derived from total 3200 trials. The four trading model has been tested 50 times on 16 different trading scenarios. To investigate the robustness of the model, each trial started on a randomly assigned day between 1st February 1991 and 1st February 2017.