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No-arbitrage conditions for storable commodities and the modeling of futures term structures

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  • Liu, Peng (Peter)
  • Tang, Ke
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Abstract

One distinguishable feature of storable commodities is that they relate to two markets: cash market and storage market. This paper proves that, if no arbitrage exists in the storage-cash dual markets, the commodity convenience yield has to be non-negative. However, classical reduced-form models for futures term structures could allow serious arbitrages due to the high volatility of the convenience yield. To avoid negative convenience yield, this paper proposes a semi-affine arbitrage-free model, which prices futures analytically and fits futures term structures reasonably well. Importantly, our model prices commodity-related contingent claims (such as calendar spread options) quite differently with classical models.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 34 (2010)
Issue (Month): 7 (July)
Pages: 1675-1687

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Handle: RePEc:eee:jbfina:v:34:y:2010:i:7:p:1675-1687

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Related research

Keywords: No-arbitrage condition Exponential affine model Convenience yield Kalman filter;

References

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Cited by:
  1. Dempster, M.A.H. & Tang, Ke, 2011. "Estimating exponential affine models with correlated measurement errors: Applications to fixed income and commodities," Journal of Banking & Finance, Elsevier, vol. 35(3), pages 639-652, March.

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