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Backwardation in Oil Futures Markets: Theory and Empirical Evidence

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Author Info
 Litzenberger, Robert H
Rabinowitz, Nir
Abstract

Oil futures prices are often below spot prices. This phenomenon, known as strong backwardation, is inconsistent with Hotelling's theory under certainty that the net price of an exhaustible resource rises over time at the rate of interest. The authors introduce uncertainty and characterize oil wells as call options. They show that production occurs only if discounted futures are below spot prices, production is nonincreasing in the riskiness of future prices, and strong backwardation emerges if the riskiness of future prices is sufficiently high. The empirical analysis indicates that U.S. oil production is inversely related and backwardation is directly related to implied volatility. Copyright 1995 by American Finance Association.

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Article provided by American Finance Association in its journal Journal of Finance.

Volume (Year): 50 (1995)
Issue (Month): 5 (December)
Pages: 1517-45
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Handle: RePEc:bla:jfinan:v:50:y:1995:i:5:p:1517-45

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  1. Svetlana Borovkova & Helyette Geman, 2006. "Seasonal and stochastic effects in commodity forward curves," Review of Derivatives Research, Springer, vol. 9(2), pages 167-186, September. [Downloadable!] (restricted)
  2. Jaime Casassus & Pierre Collin-Dufresne & Bryan R. Routledge, 2005. "Equilibrium Commodity Prices with Irreversible Investment and Non-Linear Technology," NBER Working Papers 11864, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  3. Alvaro Cartea & Marcelo G. Figueroa & Helyette Geman, 2008. "Modelling Electricity Prices with Forward Looking Capacity Constraints," Birkbeck Working Papers in Economics and Finance 0802, Birkbeck, Department of Economics, Mathematics & Statistics. [Downloadable!]
  4. Andreas Röthig, 2008. "The Impact of Backwardation on Hedgers' Demand for Currency Futures Contracts: Theory versus Empirical Evidence," Darmstadt Discussion Papers in Economics 190, Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology). [Downloadable!]
  5. Zulauf, Carl R. & Zhou, Haijiang & Roberts, Matthew C., 2005. "Updating the Estimation of the Supply of Storage Model," 2005 Annual meeting, July 24-27, Providence, RI 19122, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association). [Downloadable!]
  6. Geman, Hélyette & Roncoroni, Andrea, 2003. "A Class of Marked Point Processes for Modelling Electricity Prices," ESSEC Working Papers DR 03004, ESSEC Research Center, ESSEC Business School. [Downloadable!]
  7. Robert S. Pindyck, 2003. "Volatility In Natural Gas And Oil Markets," Working Papers 0312, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research. [Downloadable!]
  8. Murray Carlson & Zeigham Khokher & Sheridan Titman, 2006. "Equilibrium Exhaustible Resource Price Dynamics," NBER Working Papers 12000, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  9. Wai Mun Fong & Kim Hock See, 2003. "Basis variations and regime shifts in the oil futures market," European Journal of Finance, Taylor and Francis Journals, vol. 9(5), pages 499-513, October. [Downloadable!] (restricted)
  10. Anders B. Trolle & Eduardo S. Schwartz, 2006. "Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives," NBER Working Papers 12744, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  11. Jochen Moebert, 2007. "Crude Oil Price Determinants," Darmstadt Discussion Papers in Economics 186, Institut für Volkswirtschaftslehre (Department of Economics), Technische Universität Darmstadt (Darmstadt University of Technology). [Downloadable!]
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