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    A flexible model of term-structure dynamics of commodity prices: A comparative analysis with a two-factor Gaussian model

    191683_191683.pdf (1.606Mb)
    Access Status
    Open access
    Authors
    Suenaga, Hiroaki
    Date
    2013
    Type
    Journal Article
    
    Metadata
    Show full item record
    Citation
    Suenaga, Hiroaki. 2013. A flexible model of term-structure dynamics of commodity prices: A comparative analysis with a two-factor Gaussian model. Quantitative Finance. 13 (4): pp. 509-526.
    Source Title
    Quantitative Finance
    DOI
    10.1080/14697688.2013.774460
    ISSN
    1469-7696
    Remarks

    The Version of Record of this manuscript has been published and is available in Quantitative Finance (2013) http://www.tandfonline.com/10.1080/14697688.2013.774460

    URI
    http://hdl.handle.net/20.500.11937/12889
    Collection
    • Curtin Research Publications
    Abstract

    This study compares two approaches to modeling a term structure of commodity prices. The first approach specifies the stochastic process of the underlying spot price and derives from the stipulated spot price dynamics valuation formulas of futures and other derivative contracts through no arbitrage. The second approach, as introduced by Smith [J. Appl. Econometr., 2005, 20, 405–422], is to model the dynamics of the entire futures curve directly by a set of common stochastic factors and to specify factor loadings by flexible functions of time-to-maturity and contract delivery month. Empirical applications of the models to four commodities (gold, crude oil, natural gas, and corn) reveal that the volatility of futures prices exhibits more complex dynamics than the pattern implied by the model stipulating a two-factor Gaussian process of the underlying spot price. Specifically, the flexible model of futures returns depicts the maturity effect and, particularly for the three consumption commodities, strong seasonal and cross-sectional variations invariance and covariance of concurrently traded contracts. Incorporating the depicted variance and covariance dynamics leads the flexible model of futures returns to suggest hedging strategies that are more effective than the strategies based on the conventional two-factor Gaussian model.

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