Humps in the Volatility Structure of the Crude Oil Futures Market
AbstractThis paper analyzes the volatility structure of commodity derivatives markets. The model encompasses stochastic volatility that may be unspanned by futures contracts. A generalized hump-shaped volatility specification is assumed that entails a finite-dimensional affine model for the commodity futures curve and quasi-analytical prices for options on commodity futures. An empirical study of the crude oil futures volatility structure is carried out using an extensive database of futures prices as well as futures option prices spanning 21 years. The study supports a hump-shaped, partially spanned stochastic volatility specification. Factor hedging, which takes into account shocks to both the volatility processes and the futures curve, depicts the presence of unspanned components in the volatility of commodity futures and the outperformance of the hump-shaped volatility in comparison to the more popular exponential decaying volatility. This hump shaped feature is more pronounced when the market is volatile.
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Bibliographic InfoPaper provided by Quantitative Finance Research Centre, University of Technology, Sydney in its series Research Paper Series with number 308.
Date of creation: 01 Jun 2012
Date of revision:
commodity derivatives; crude oil derivatives; Unspanned stochastic volatility; hump-shaped volatility; pricing; hedging;
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-09-03 (All new papers)
- NEP-BEC-2012-09-03 (Business Economics)
- NEP-CWA-2012-09-03 (Central & Western Asia)
- NEP-ENE-2012-09-03 (Energy Economics)
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