Why and when do spot prices of crude oil revert to futures price levels?
Recent studies of crude oil price formation emphasize the role of interest rates and convenience yield (the adjusted spot-futures spread), confirming that spot prices mean-revert and normally exceed discounted futures. However, these studies don't explain why such "backwardation" is normal. Also, models derived in these studies typically explain only about 1 percent of daily returns, suggesting other factors are important, too. In this paper, I specify a structural oil-market model that links returns to convenience yield, inventory news, and revisions of expected production cost (growth of which is related to backwardation). Although its predictive power is only a marginal improvement, the model fits the data far better. In addition, I find reversion of spot to futures prices only when backwardation is severe. Convenience yield behaves nonlinearly, but price response to convenience yield is also nonlinear. Equivalently, futures are informative about future spot prices only when spot prices substantially exceed futures.
|Date of creation:||2005|
|Date of revision:|
|Contact details of provider:|| Postal: 20th Street and Constitution Avenue, NW, Washington, DC 20551|
Web page: http://www.federalreserve.gov/
More information through EDIRC
|Order Information:||Web: http://www.federalreserve.gov/pubs/feds/fedsorder.html|
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Colin A. Carter & Cesar L. Revoredo Giha, 2007. "The Working Curve and Commodity Storage under Backwardation," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 89(4), pages 864-872.
- Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
- Deaton, A. & Laroque, G., 1989.
"On The Behavior Of Commodity Prices,"
145, Princeton, Woodrow Wilson School - Development Studies.
- Bryan Routledge & Duane Seppi & Chester Spatt, .
"Equilibrium Forward Curves for Commodities,"
GSIA Working Papers
1997-49, Carnegie Mellon University, Tepper School of Business.
- Robert S. Pindyck, 1999.
"The Long-Run Evolutions of Energy Prices,"
The Energy Journal,
International Association for Energy Economics, vol. 0(Number 2), pages 1-27.
- Robert S. Pindyck, 1992.
"The Present Value Model of Rational Commodity Pricing,"
NBER Working Papers
4083, National Bureau of Economic Research, Inc.
- Pindyck, Robert S, 1993. "The Present Value Model of Rational Commodity Pricing," Economic Journal, Royal Economic Society, vol. 103(418), pages 511-30, May.
- Pindyck, Robert S., 1991. "The present value model of rational commodity pricing," Working papers 3354-91., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Williams,Jeffrey C. & Wright,Brian D., 2005.
"Storage and Commodity Markets,"
Cambridge University Press, number 9780521023399, November.
- Danthine, Jean-Pierre, 1977. "Martingale, market efficiency and commodity prices," European Economic Review, Elsevier, vol. 10(1), pages 1-17.
- Schwartz, Eduardo S, 1997. " The Stochastic Behavior of Commodity Prices: Implications for Valuation and Hedging," Journal of Finance, American Finance Association, vol. 52(3), pages 923-73, July.
- Considine, Timothy J. & Larson, Donald F., 2001. "Uncertainty and the convenience yield in crude oil price backwardations," Energy Economics, Elsevier, vol. 23(5), pages 533-548, September.
- Robert S. Pindyck, 2001. "The Dynamics of Commodity Spot and Futures Markets: A Primer," The Energy Journal, International Association for Energy Economics, vol. 0(Number 3), pages 1-30.
- Malcolm P. Baker & E. Scott Mayfield & John E. Parsons, 1998. "Alternative Models of Uncertain Commodity Prices for Use with Modern Asset Pricing Methods," The Energy Journal, International Association for Energy Economics, vol. 0(Number 1), pages 115-148.
When requesting a correction, please mention this item's handle: RePEc:fip:fedgfe:2005-30. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Marlene Vikor)
If references are entirely missing, you can add them using this form.