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Commodity derivatives pricing with inventory effects

Author

Listed:
  • Christian Bach

    () (Aarhus University and CREATES)

  • Matt P. Dziubinski

    () (Aarhus University and CREATES)

Abstract

We introduce tractable models for commodity derivatives pricing with inventory and volatility effects, and illustrate with applications to the oil market. We contribute to the existing literature in several respects. First, whereas the previous literature uses futures data for investigating the relationship between inventory and volatility, we use the information available in options traded on futures. Second, performance assessment in the previous literature has primarily evolved around explaining moments of data or forecasting prices of futures. Instead, we assess the performance of our model by considering both the ability of explaining prices in-sample and out-of-sample - assessing both the pricing-performance and the hedging-performance of the models. Third, we model the futures surface rather than the spot price process, and from the no-arbitrage relationship between spot and futures prices we limit the number of parameters to calibrate. We introduce a new, maturity-wise calibration method compatible with this modeling methodology. Fourth, we use actual data on inventories rather than a proxy. Fifth, our model is very flexible and allows for testing several different types of relationships between inventory and volatility.

Suggested Citation

  • Christian Bach & Matt P. Dziubinski, 2012. "Commodity derivatives pricing with inventory effects," CREATES Research Papers 2012-06, Department of Economics and Business Economics, Aarhus University.
  • Handle: RePEc:aah:create:2012-06
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    File URL: ftp://ftp.econ.au.dk/creates/rp/12/rp12_06.pdf
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    Keywords

    Energy futures and options markets; energy price volatility; commodities; crude oil; stochastic volatility; stochastic inventories; inventories; option pricing; scarcity.;

    JEL classification:

    • C51 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Construction and Estimation
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General

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