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Time-varying long-run mean of commodity prices and the modeling of futures term structures

Listed author(s):
  • Ke Tang
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The exploration of the mean-reversion of commodity prices is important for inventory management, inflation forecasting and contingent claim pricing. Bessembinder et al. [ J . Finance , 1995, 50 , 361--375] document the mean-reversion of commodity spot prices using futures term structure data; however, mean-reversion to a constant level is rejected in nearly all studies using historical spot price time series. This indicates that the spot prices revert to a stochastic long-run mean. Recognizing this, I propose a reduced-form model with the stochastic long-run mean as a separate factor. This model fits the futures dynamics better than do classical models such as the Gibson--Schwartz [ J . Finance , 1990, 45 , 959--976] model and the Casassus--Collin-Dufresne [ J . Finance , 2005, 60 , 2283--2331] model with a constant interest rate. An application for option pricing is also presented in this paper.

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Article provided by Taylor & Francis Journals in its journal Quantitative Finance.

Volume (Year): 12 (2012)
Issue (Month): 5 (April)
Pages: 781-790

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Handle: RePEc:taf:quantf:v:12:y:2012:i:5:p:781-790
DOI: 10.1080/14697688.2010.488654
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