Multi-Factor Model of Correlated Commodity - Forward Curves for Crude Oil and Shipping Markets
AbstractAn arbitrage free multi-factor model is developed of the correlated forward curves of the crude oil, gasoline, heating oil and tanker shipping markets. Futures contracts trading on public exchanges are used as the primary underlying securities for the development of a multi-factor Gaussian Heath-Jarrow-Morton (HJM) model for the dynamic evolution of the correlated forward curves. An intra- and inter-commodity Principal Component Analysis (PCA) is carried out in order to isolate seasonality and identify a small number of independent factors driving each commodity market. The cross-commodity correlation of the factors is estimated by a two step PCA. The factor volatilities and cross-commodity factor correlations are studied in order to identify stable parametric models, heteroskedasticity and seasonality in the factor volatilities and correlations. The model leads to explicit stochastic differential equations governing the short term and long term factors driving the price of the spot commodity under the risk neutral measure. Risk premia are absent, consistently with HJM arbitrage free framework, as they are imbedded in the factor volatilities and correlations estimated by the PCA. The use of the model is described for the pricing of derivatives written on inter- and intra-commodity futures spreads, Asian options, the valuation and hedging of energy and shipping assets, the fuel efficient navigation of shipping fleets and use in corporate risk management.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research in its series Working Papers with number 0902.
Date of creation: Mar 2009
Date of revision:
Contact details of provider:
Postal: 77 Massachusetts Ave. (Building E40-279), Cambridge, MA 02139-4307
Phone: (617) 253-3551
Fax: (617) 253-9845
Web page: http://tisiphone.mit.edu/RePEc
More information through EDIRC
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-06-17 (All new papers)
- NEP-ENE-2009-06-17 (Energy Economics)
- NEP-RMG-2009-06-17 (Risk Management)
You can help add them by filling out this form.
reading list or among the top items on IDEAS.Access and download statisticsgeneral information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Sharmila Ganguly).
If references are entirely missing, you can add them using this form.