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Futures Prices in a Production Economy with Investment Constraints

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  • Amir Yaron
  • Leonid Kogan
  • Dmitry Livdan

Abstract

We document a new stylized fact regarding the term-structure of futures volatility. We show that the relationship between the volatility of futures prices and the slope of the term structure of prices is non-monotone and has a \V-shape". This aspect of the data cannot be generated by basic models that emphasize storage while this fact is consistent with models that emphasize investment constraints or, more generally, time-varying elasticity of supply. We develop an equilibrium model in which futures prices are determined endogenously in a production economy in which investment is both irreversible and is capacity constrained. Investment constraints a?ect ?rms investment decisions, which in turn determine the dynamic properties of their output and consequently imply that the elasticity of supply of the commodity changes over time. Since demand shocks must be absorbed either by changes in prices, or by changes in supply, time-varying supply elasticity results in time-varying volatility of futures prices. Calibrating this model, we show it is quantitatively consistent with the aforementioned V-shape" relationship between the volatility of futures prices and the slope of the term-structure

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Bibliographic Info

Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 128.

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Date of creation: 2004
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Handle: RePEc:red:sed004:128

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Keywords: Futures prices; Invest; ment Constraints;

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References

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  1. Lucas, Robert E, Jr & Prescott, Edward C, 1971. "Investment Under Uncertainty," Econometrica, Econometric Society, vol. 39(5), pages 659-81, September.
  2. Deaton, A. & Laroque, G., 1989. "On The Behavior Of Commodity Prices," Papers 145, Princeton, Woodrow Wilson School - Public and International Affairs.
  3. Lee, Bong-Soo & Ingram, Beth Fisher, 1991. "Simulation estimation of time-series models," Journal of Econometrics, Elsevier, vol. 47(2-3), pages 197-205, February.
  4. Duffie, Darrell & Singleton, Kenneth J, 1993. "Simulated Moments Estimation of Markov Models of Asset Prices," Econometrica, Econometric Society, vol. 61(4), pages 929-52, July.
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  6. Deaton, A. & Laroque, G., 1996. "Competitive storage and commodity price dynamics," Open Access publications from University College London http://discovery.ucl.ac.u, University College London.
  7. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-57, April.
  8. Williams,Jeffrey C. & Wright,Brian D., 1991. "Storage and Commodity Markets," Cambridge Books, Cambridge University Press, number 9780521326162.
  9. Lester G. Telser, 1958. "Futures Trading and the Storage of Cotton and Wheat," Journal of Political Economy, University of Chicago Press, vol. 66, pages 233.
  10. 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 923-73, July.
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Cited by:
  1. Lanza, Alessandro & Manera, Matteo & McAleer, Michael, 2006. "Modeling dynamic conditional correlations in WTI oil forward and futures returns," Finance Research Letters, Elsevier, vol. 3(2), pages 114-132, June.
  2. Murray Carlson & Zeigham Khokher & Sheridan Titman, 2007. "Equilibrium Exhaustible Resource Price Dynamics," Journal of Finance, American Finance Association, vol. 62(4), pages 1663-1703, 08.
  3. Fink, Jason D. & Fink, Kristin E. & Russell, Allison, 2010. "When and how do tropical storms affect markets? The case of refined petroleum," Energy Economics, Elsevier, vol. 32(6), pages 1283-1290, November.
  4. Razvan Tudor, 2009. "Evidence of unspanned stochastic volatility in crude-oil market," Advances in Economic and Financial Research - DOFIN Working Paper Series 33, Bucharest University of Economics, Center for Advanced Research in Finance and Banking - CARFIB.
  5. Miguel Herce & John E. Parsons & Robert C. Ready, 2006. "Using Futures Prices to Filter Short-term Volatility and Recover a Latent, Long-term Price Series for Oil," Working Papers 0605, Massachusetts Institute of Technology, Center for Energy and Environmental Policy Research.

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