Establishing a framework to forecast equity Indices and commodity prices for the purpose of risk management

Abstract

Abstract Research Objective • To establish a methodology that can be used to forecast the prices of various kinds of assets. • The main objective is not to predict the exact price of the above assets in the future but it is to obtain a distribution of the prices which in effect can be used by various people for scenario generation. Which is a necessary input to risk management? Findings The Hybrid Model which is a combination of the Mean Reversion model and The Random Walk Model gives a good approximation for forecasting the distribution of the asset prices over a relatively longer term. The outputs of the model are the mean prices and the variances at different points of time . The results if back-testing suggest that the actual prices are always within the distribution forecasted by the hybrid model.

Limitations of the study: The framework developed in the study should only be used for the purpose of risk management and should not to be used for predicting exact future prices of either indices or commodities. The framework developed is applicable only to assets which follow a log normal distribution and hence it should not be used for forecasting asset prices which follow a significantly different distribution.