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Generic Price Model for Commodity Derivatives

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  • Lee, David

Abstract

This article develops a new framework for modeling the dynamics of commodity forward curves and pricing commodity derivatives. The model accommodates a generic calibration procedure to ensure that the model prices for vanilla options match exactly the market prices. Empirically we show that the model prices are within the bid-offer spreads, indicating prima facie that the model performs quite well. We also show that the model prices for non-vanilla options are in good agreement with the market prices and the implied model dynamics are in good agreement with the characteristics of the historical data series.

Suggested Citation

  • Lee, David, 2022. "Generic Price Model for Commodity Derivatives," MPRA Paper 114283, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:114283
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    File URL: https://mpra.ub.uni-muenchen.de/114283/1/MPRA_paper_114283.pdf
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    References listed on IDEAS

    as
    1. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, vol. 46(7), pages 893-911, July.
    2. Svetlana Borovkova & Helyette Geman, 2006. "Seasonal and stochastic effects in commodity forward curves," Review of Derivatives Research, Springer, vol. 9(2), pages 167-186, September.
    3. Schwartz, Eduardo S, 1997. "The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-973, July.
    4. Fred Espen Benth & Jūratė Šaltytė-Benth, 2004. "The Normal Inverse Gaussian Distribution And Spot Price Modelling In Energy Markets," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 7(02), pages 177-192.
    5. Ladokhin, Sergiy & Borovkova, Svetlana, 2021. "Three-factor commodity forward curve model and its joint P and Q dynamics," Energy Economics, Elsevier, vol. 101(C).
    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    commodity derivatives; multiple factor model; model calibration; volatility skew;
    All these keywords.

    JEL classification:

    • C5 - Mathematical and Quantitative Methods - - Econometric Modeling
    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation

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