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No-arbitrage conditions for storable commodities and the modeling of futures term structures

Listed author(s):
  • Liu, Peng (Peter)
  • Tang, Ke
Registered author(s):

One distinguishable feature of storable commodities is that they relate to two markets: cash market and storage market. This paper proves that, if no arbitrage exists in the storage-cash dual markets, the commodity convenience yield has to be non-negative. However, classical reduced-form models for futures term structures could allow serious arbitrages due to the high volatility of the convenience yield. To avoid negative convenience yield, this paper proposes a semi-affine arbitrage-free model, which prices futures analytically and fits futures term structures reasonably well. Importantly, our model prices commodity-related contingent claims (such as calendar spread options) quite differently with classical models.

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File URL: http://www.sciencedirect.com/science/article/pii/S0378-4266(10)00111-1
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Article provided by Elsevier in its journal Journal of Banking & Finance.

Volume (Year): 34 (2010)
Issue (Month): 7 (July)
Pages: 1675-1687

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Handle: RePEc:eee:jbfina:v:34:y:2010:i:7:p:1675-1687
Contact details of provider: Web page: http://www.elsevier.com/locate/jbf

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