Commodity derivatives valuation with autoregressive and moving average components in the price dynamics |
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Authors: | Raphael Paschke Marcel Prokopczuk |
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Institution: | 1. Department of Finance, University of Mannheim, 68131 Mannheim, Germany;2. ICMA Centre, Henley Business School, University of Reading, Reading RG1 5NE, UK |
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Abstract: | In this paper, we develop a continuous time factor model of commodity prices that allows for higher-order autoregressive and moving average components. We document the need for these components by analyzing the convenience yield’s time series dynamics. The model we propose is analytically tractable and allows us to derive closed-form pricing formulas for futures and options. Empirically, we estimate a parsimonious version of the general model for the crude oil futures market and demonstrate the model’s superior performance in pricing nearby futures contracts in- and out-of-sample. Most notably, the model substantially improves the pricing of long-horizon contracts with information from the short end of the futures curve. |
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Keywords: | G13 C50 Q40 |
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