A hybrid crude oil price forecasting framework: Modified ensemble empirical mode decomposition and hidden Markov regression

Abstract

AbstractThe considerable influence of crude oil prices on the international economy has motivated numerous scholars to develop various prediction models. Two difficulties are encountered in forecasting. One is that the time series of crude oil prices show massive jumps in high frequency. The other is that the time series of crude oil prices are characterised by nonlinearity, structural breaks and highly volatile states. Therefore, we propose a hybrid model that incorporates the principle of decomposition–integration. Its overall process can be divided into the steps of decomposition and integration. In decomposition step, modified ensemble empirical mode decomposition is used to decompose the data on crude oil prices. Next, K‐means and principal component analysis are utilised to extract the optimal intrinsic mode function (IMF) from diverse frequencies amongst decomposed IMFs. Following decomposition, different forecasting methods are used to match IMFs with various frequencies for prediction. In accordance with structural breaks and the highly volatile states of high‐frequency series, hidden Markov regression is applied to describe predicted values in a probabilistic manner, providing objective interpretation and forecasting. A neural network is taken to predict intermediate‐frequency IMFs by using a fully connected network. Owing to the low frequency and tendency of the residual sequence to be more stable than other frequency sequences, the autoregressive integrated moving average model is applied as the forecasting method for prediction. Finally, all individual predictions for the eventual results are ensembled as final predictions. Results confirm that the proposed model is better than several normal hybrid and single models in terms of prediction accuracy and Diebold–Mariano test results. All results confirm that the newly proposed hybrid model is a promising tool for the analysis and forecasting of crude oil prices.