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On Term Structure Models of Commodity Futures Prices and the Kaldor-Working Hypothesis

  • Power, Gabriel J.
  • Turvey, Calum G.

Both prices and the volatility of storable agricultural commodity futures contracts have been rising since 2005 and particularly since 2007. This paper aims to answer two principal questions: (i) How has the behavior of these futures prices over time and across maturities changed with the rise of biofuels and their demand-side pres- sure on corn and related crops?, and (ii) Is there now stronger or weaker evidence of the Kaldor-Working convenience yield-storage hypothesis, whereby futures price backwardation can be explained by the high value of remaining inventory stocks when these are near stockouts? The empirical application is to Chicago Board of Trade corn, wheat and soybeans futures. To make use of all available futures data rather than only the nearby, this paper adopts a recently developed affine term structure model approach and conducts estimation in state-space form using the Kalman filter. A novel aspect of the research is that it allows an arbitrary number N of state vari- ables, where more variables provide further precision and curvature but at a higher computational cost. It is found that a three-state variable model containing both ran- dom walk and mean reversion components provides the most parsimonious fit during 1988-2004, but that a simple one-state variable model is optimal for the period 2005- 2007. The main implication is that futures prices since 2005 behave much more like a \random walk" than before. Also, the model allows us to estimate the term struc- ture of volatility and it is found that distant maturity futures should be expected to be much more volatile than historically normal. Two practical but only tentative implications are: (a) hedgers should use significantly lower hedge ratios than before, and (b) for traders, the classic Black-Scholes option pricing solution should perform better now than it has historically. Lastly, the paper finds partial empirical support for the convenience yield relationship with relative inventory stocks, especially for soybeans and wheat.

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Paper provided by NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management in its series 2008 Conference, April 21-22, 2008, St. Louis, Missouri with number 37608.

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Date of creation: 2008
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Handle: RePEc:ags:nccest:37608
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  1. Serena Ng & Francisco J. Ruge-Murcia, 2000. "Explaining the Persistence of Commodity Prices," Computational Economics, Society for Computational Economics, vol. 16(1/2), pages 149-171, October.
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  6. Nguyen, Vu-Nhat & Geman, Hélyette, 2005. "Soybean Inventory and Forward Curve Dynamics," Economics Papers from University Paris Dauphine 123456789/1937, Paris Dauphine University.
  7. Smith, Aaron D., 2004. "Partially Overlapping Time Series: A New Model for Volatility Dynamics in Commodity Futures," Working Papers 11978, University of California, Davis, Department of Agricultural and Resource Economics.
  8. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-54, May-June.
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  11. Eduardo Schwartz & James E. Smith, 2000. "Short-Term Variations and Long-Term Dynamics in Commodity Prices," Management Science, INFORMS, vol. 46(7), pages 893-911, July.
  12. Scott H. Irwin & Carl R. Zulauf & Thomas E. Jackson, 1996. "Monte Carlo Analysis of Mean Reversion in Commodity Futures Prices," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 78(2), pages 387-399.
  13. Karali, Berna & Thurman, Walter N., 2008. "Volatility Persistence in Commodity Futures:Inventory and Time-to-Delivery Effects," 2008 Conference, April 21-22, 2008, St. Louis, Missouri 37612, NCCC-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
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  18. repec:cup:cbooks:9780521637695 is not listed on IDEAS
  19. Jaime Casassus & Pierre Collin-Dufresne, 2005. "Stochastic Convenience Yield Implied from Commodity Futures and Interest Rates," Journal of Finance, American Finance Association, vol. 60(5), pages 2283-2331, October.
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  21. Brennan, Donna & Williams, Jeffrey & Wright, Brian D, 1997. "Convenience Yield without the Convenience: A Spatial-Temporal Interpretation of Storage under Backwardation," Economic Journal, Royal Economic Society, vol. 107(443), pages 1009-22, July.
  22. Anders B. Trolle & Eduardo S. Schwartz, 2006. "A General Stochastic Volatility Model for the Pricing and Forecasting of Interest Rate Derivatives," NBER Working Papers 12337, National Bureau of Economic Research, Inc.
  23. Gibson, Rajna & Schwartz, Eduardo S, 1990. " Stochastic Convenience Yield and the Pricing of Oil Contingent Claims," Journal of Finance, American Finance Association, vol. 45(3), pages 959-76, July.
  24. Anderson, Ronald W & Danthine, Jean-Pierre, 1983. "The Time Pattern of Hedging and the Volatility of Futures Prices," Review of Economic Studies, Wiley Blackwell, vol. 50(2), pages 249-66, April.
  25. Bessembinder, Hendrik, et al, 1995. " Mean Reversion in Equilibrium Asset Prices: Evidence from the Futures Term Structure," Journal of Finance, American Finance Association, vol. 50(1), pages 361-75, March.
  26. Lin, Chuanyi & Roberts, Matthew C., 2006. "A Term Structure Model for Commodity Prices: Does Storability Matter?," 2006 Conference, April 17-18, 2006, St. Louis, Missouri 18993, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
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  28. repec:cup:cbooks:9780521326162 is not listed on IDEAS
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