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Drift matters: An analysis of commodity derivatives

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  • Olaf Korn

Abstract

This article presents a reduced‐form, two‐factor model to price commodity derivatives, which generalizes the model by Schwartz and Smith (2000). The model allows for two mean‐reverting stochastic factors and therefore implies that spot and futures prices can be stationary. An empirical study for the crude oil market tests the new model. Out‐of‐sample pricing and hedging results for futures and forwards show that the new model dominates the nonstationary model by Schwartz and Smith in the following sense: It works equally well for short‐term contracts but leads to major improvements for long‐term contracts. This finding is particularly relevant for typical applications like the valuation of commodity‐linked real assets with long maturities. © 2005 Wiley Periodicals, Inc. Jrl Fut Mark 25:211–241, 2005

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  • Olaf Korn, 2005. "Drift matters: An analysis of commodity derivatives," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 25(3), pages 211-241, March.
    • Handle: RePEc:wly:jfutmk:v:25:y:2005:i:3:p:211-241
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    Cited by:

    1. Björn Lutz, 2010. "Pricing of Derivatives on Mean-Reverting Assets," Lecture Notes in Economics and Mathematical Systems, Springer, number 978-3-642-02909-7, December.
    2. W. Keener Hughen, 2010. "A maximal affine stochastic volatility model of oil prices," Journal of Futures Markets, John Wiley & Sons, Ltd., vol. 30(2), pages 101-133, February.
    3. Marcel Prokopczuk & Yingying Wu, 2013. "Estimating term structure models with the Kalman filter," Chapters, in: Adrian R. Bell & Chris Brooks & Marcel Prokopczuk (ed.), Handbook of Research Methods and Applications in Empirical Finance, chapter 4, pages 97-113, Edward Elgar Publishing.
    4. Power, Gabriel J. & Eaves, James & Turvey, Calum & Vedenov, Dmitry, 2017. "Catching the curl: Wavelet thresholding improves forward curve modelling," Economic Modelling, Elsevier, vol. 64(C), pages 312-321.
    5. Max F. Schöne & Stefan Spinler, 2017. "A four-factor stochastic volatility model of commodity prices," Review of Derivatives Research, Springer, vol. 20(2), pages 135-165, July.

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