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A Two-Factor Cointegrated Commodity Price Model with an Application to Spread Option Pricing


Farkas, Walter; Gourier, Elise; Huitema, Robert; Necula, Ciprian (2017). A Two-Factor Cointegrated Commodity Price Model with an Application to Spread Option Pricing. Journal of Banking and Finance, 77:249-268.

Abstract

In this paper, we propose an easy-to-use yet comprehensive model for a system of cointegrated commodity prices. While retaining the exponential affine structure of previous approaches, our model allows for an arbitrary number of cointegration relationships. We show that the cointegration component allows capturing well-known features of commodity prices, i.e., upward sloping (contango) and downward sloping (backwardation) term-structures, smaller volatilities for longer maturities and an upward sloping correlation term structure. The model is calibrated to futures price data of ten commodities. The results provide compelling evidence of cointegration in the data. Implications for the prices of futures and options written on common commodity spreads (e.g., spark spread and crack spread) are thoroughly investigated.

Abstract

In this paper, we propose an easy-to-use yet comprehensive model for a system of cointegrated commodity prices. While retaining the exponential affine structure of previous approaches, our model allows for an arbitrary number of cointegration relationships. We show that the cointegration component allows capturing well-known features of commodity prices, i.e., upward sloping (contango) and downward sloping (backwardation) term-structures, smaller volatilities for longer maturities and an upward sloping correlation term structure. The model is calibrated to futures price data of ten commodities. The results provide compelling evidence of cointegration in the data. Implications for the prices of futures and options written on common commodity spreads (e.g., spark spread and crack spread) are thoroughly investigated.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Language:English
Date:April 2017
Deposited On:08 Nov 2017 13:07
Last Modified:20 Sep 2018 04:25
Publisher:Elsevier
ISSN:0378-4266
OA Status:Closed
Free access at:Related URL. An embargo period may apply.
Publisher DOI:https://doi.org/10.1016/j.jbankfin.2017.01.007
Related URLs:http://www.sciencedirect.com/science/article/pii/S0378426617300109 (Publisher)
https://www.zora.uzh.ch/id/eprint/115033/
Other Identification Number:merlin-id:14476

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