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Oil convenience yields estimated under demand/supply shock

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  • William Lin
  • Chang-Wen Duan

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    Abstract

    This paper extends the call option model of Milonas and Thomadakis (1997) to estimate oil convenience yields with futures prices. We define the business cycle of a seasonal commodity with demand/supply shocks and find that the convenience yield for crude oil exhibits seasonal behavior. The convenience yield for West Texas Intermediate (WTI) crude oil is the highest in the summer, while that for Brent crude oil is the highest in the winter. This implies that WTI crude oil is more sensitive to high summer demand and that Brent crude oil is more sensitive to shortages in winter supply. Convenience yields are negatively related to the inventory level of the underlying crude oil and positively related to interest rates due to the business cycle. We also show that convenience yields may explain price spread between WTI crude oil and Brent crude oil. Our computed convenience yields are consistent with Fama and French (1988) in that oil prices are more volatile than futures prices at low inventory level, verifying the Samuelson (1965) hypothesis that future prices are less variables than spot prices at lower inventory levels. Copyright Springer Science+Business Media, LLC 2007

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    File URL: http://hdl.handle.net/10.1007/s11156-006-0008-5
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    Bibliographic Info

    Article provided by Springer in its journal Review of Quantitative Finance and Accounting.

    Volume (Year): 28 (2007)
    Issue (Month): 2 (February)
    Pages: 203-225

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    Handle: RePEc:kap:rqfnac:v:28:y:2007:i:2:p:203-225

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    Web page: http://springerlink.metapress.com/link.asp?id=102990

    Related research

    Keywords: Business cycle; Convenience yield; Demand/supply shock; Theory of storage; Two-period model;

    References

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    1. Bresnahan, Timothy F & Spiller, Pablo T, 1986. "Futures Market Backwardation under Risk Neutrality," Economic Inquiry, Western Economic Association International, vol. 24(3), pages 429-41, July.
    2. Gibson, Rajna & Schwartz, Eduardo S, 1990. " Stochastic Convenience Yield and the Pricing of Oil Contingent Claims," Journal of Finance, American Finance Association, vol. 45(3), pages 959-76, July.
    3. Fama, Eugene F & French, Kenneth R, 1988. " Business Cycles and the Behavior of Metals Prices," Journal of Finance, American Finance Association, vol. 43(5), pages 1075-93, December.
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    Cited by:
    1. Lautier, Delphine, 2009. "Convenience Yield and Commodity Markets," Economics Papers from University Paris Dauphine 123456789/2274, Paris Dauphine University.

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