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Pricing and hedging of long-term futures and forward contracts by a three-factor model

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  • Kenichiro Shiraya
  • Akihiko Takahashi

Abstract

This paper demonstrates the pricing and hedging efficiency of a three-factor stochastic mean reversion Gaussian model of commodity prices using oil and copper futures and forward contracts. The model is estimated using NYMEX WTI (light sweet crude oil) and LME Copper futures prices and is shown to fit the data well. Furthermore, it shows how to hedge based on a three-factor model and confirms that using three different futures contracts to hedge long-term contracts outperforms the traditional parallel hedge based on a single futures position by time series data and simulation. It also finds that the three-factor model outperforms the two-factor version with respect to the replication of actual term structures and that stochastic mean reversion models outperform constant mean reversion models in Out of Sample hedges.

Suggested Citation

  • Kenichiro Shiraya & Akihiko Takahashi, 2012. "Pricing and hedging of long-term futures and forward contracts by a three-factor model," Quantitative Finance, Taylor & Francis Journals, vol. 12(12), pages 1811-1826, December.
    • Handle: RePEc:taf:quantf:v:12:y:2012:i:12:p:1811-1826
    DOI: 10.1080/14697680903341780
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    Citations

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    Cited by:

    1. Benjamin Cheng & Christina Sklibosios Nikitopoulos & Erik Schlögl, 2019. "Interest rate risk in long‐dated commodity options positions: To hedge or not to hedge?," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 39(1), pages 109-127, January.
    2. Benjamin Cheng & Christina Nikitopoulos-Sklibosios & Erik Schlogl, 2016. "Empirical Hedging Performance on Long-Dated Crude Oil Derivatives," Research Paper Series 376, Quantitative Finance Research Centre, University of Technology, Sydney.
    3. repec:uts:finphd:37 is not listed on IDEAS
    4. Takashi Kato & Jun Sekine & Hiromitsu Yamamoto, 2014. "A One-Factor Conditionally Linear Commodity Pricing Model under Partial Information," Asia-Pacific Financial Markets, Springer;Japanese Association of Financial Economics and Engineering, vol. 21(2), pages 151-174, May.
    5. James S. Doran & Ehud I. Ronn, 2021. "Hedging Long-Dated Oil Futures and Options Using Short-Dated Securities—Revisiting Metallgesellschaft," JRFM, MDPI, vol. 14(8), pages 1-10, August.
    6. Takashi Kato & Jun Sekine & Hiromitsu Yamamoto, 2014. "A One-Factor Conditionally Linear Commodity Pricing Model under Partial Information," Papers 1406.4275, arXiv.org.
    7. Benjamin Cheng & Christina Nikitopoulos-Sklibosios & Erik Schlogl, 2016. "Hedging Futures Options with Stochastic Interest Rates," Research Paper Series 375, Quantitative Finance Research Centre, University of Technology, Sydney.

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