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Can we derive energy price in 2011 Q2 from Devon Energy share price?

May 01, 2011 2:42 AM ET
Ivan Kitov profile picture
Ivan Kitov's Blog
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Medium-Term Horizon, Macro, Oil & Gas

Seeking Alpha Analyst Since 2009

I am a Doctor of Physics and Mathematics, Lead Researcher at the Institute for the Geospheres' Dynamics, Russian Academy of Sciences. In economics and finances, we apply strict quantitative methods, like those in classical mechanics, to predict the evolution of measured economic and financial variables: real GDP, inflation, unemployment, labor productivity, labor participation rate, personal income distribution, firm size distribution, S&P 500 returns, prices of commodities and shares of S&P 500 companies. We give only varified quantitative predictions - less words, more figures. Download original articles and working papers from Research Papers in Economics: http://ideas.repec.org/e/pki113.html
We have already presented about 30 deterministic models for share prices from the S&P 500 list. The existence of these deterministic models might be perceived as if the stock market does not drive real economy, i.e. the stock market lags behind the economy and does not use all currently available information. It was not our intention to mislead the reader. On the contrary, we have tried to help investors. To recover our belief in real economic forces as expressed in stock pricing we have presented rough models of oil-related companies: XOM, COP, DVN, HAL, and CVX. Their share prices lead defining CPI components by several months. In other words, the defining consumer price indices (CPI and core CPI in these rough models) lag behind oil price.
In this post we refine the price model for Devon Energy Corporation (DVN) using an extended set of 92 CPIs. Even in this case, Devon Energy provides an example of a company whose share price has been leading defining components of the CPI. As always, the model is seeking for two CPI components which minimize the difference between observed (monthly closing price adjusted for dividends and splits) and predicted prices for the period between July 2003 and March 2011.
The two-component (2-C) model also includes free term (constant) and linear time term which compensates well know linear (time) trends between various CPI components. The best-fit 2-C model for DVN(t) is as follows:
DVN(t)= 2.70CF(t-2) + 0.49E(t+3) – 12.21(t-1990) – 370.88
where CF in the headline CPI less food leading the stock price by 2 months, E is the index of energy lagging behind by 3 months, (t-1990) is the elapsed time. Therefore, the predicted curve should lag the observed price by 3 months. In other words, the price of a DVN share defines the behaviour of the index of energy. Figure 1 depicts the observed and predicted prices, the latter shifted three months ahead for synchronization. The model residual error, i.e. standard deviation, is of $5.54for the period between July 2003 and December 2010.
The DVN model does not predict the share price. However, the share price in the first quarter of 2011 demands both indices to grow in 2001 Q2. It is most likely that the index of energy will grow much faster than the CF.
Figure 1. Observed and predicted DVN share prices.
Figure 2. The index of energy, E, and the CPI less food, CF.

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