IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Login to save this paper or follow this series

Equilibrium Commodity Prices with Irreversible Investment and Non-Linear Technology

  • Jaime Cacassus
  • Pierre Collin-Dufresne
Registered author(s):

    We model the properties of equilibrium spot and futures oil prices in a general equilibrium production economy with two goods. In our model production of the consumption good requires two inputs: the consumption good and a Oil. Oil is produced by wells whose flow rate is costly to adjust. Investment in new Oil wells is costly and irreversible. As a result in equilibrium, investment in Oil wells is infrequent and lumpy. Equilibrium spot price behavior is determined as the shadow value of oil. The resulting equilibrium oil price exhibits mean-reversion and heteroscedasticity. Further, even though the state of the economy is fully described by a one-factor Markov process, the spot oil price is not Markov (in itself). Rather it is best described as a regime-switching process, the regime being an investment `proximity' indicator. Further, our model captures many of the stylized facts of oil futures prices. The futures curve exhibits backwardation as a result of a convenience yield, which arises endogenously due to the productive value of oil as an input for production. This convenience yield is decreasing in the amount of oil available in the economy. We test out model using crude oil data from 1982 to 2003. We estimate a linear approximation of the equilibrium regime-shifting dynamics implied by our model. Our empirical specification successfully captures spot and futures data. Finally, the specific empirical implementation we use is designed to easily facilitate commodity derivative pricing that is common in two-factor reduced form pricing models.

    To our knowledge, this item is not available for download. To find whether it is available, there are three options:
    1. Check below under "Related research" whether another version of this item is available online.
    2. Check on the provider's web page whether it is in fact available.
    3. Perform a search for a similarly titled item that would be available.

    Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 863.

    as
    in new window

    Length:
    Date of creation: 2004
    Date of revision:
    Handle: RePEc:red:sed004:863
    Contact details of provider: Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
    Fax: 1-314-444-8731
    Web page: http://www.EconomicDynamics.org/society.htm
    Email:


    More information through EDIRC

    No references listed on IDEAS
    You can help add them by filling out this form.

    This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

    When requesting a correction, please mention this item's handle: RePEc:red:sed004:863. 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: (Christian Zimmermann)

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If references are entirely missing, you can add them using this form.

    If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.