No-arbitrage conditions for storable commodities and the modeling of futures term structures |
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Authors: | Peng Liu Ke Tang |
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Institution: | 1. School of Hotel Administration, Cornell University, 465 Statler Hall, Ithaca, NY 14850, USA;2. Hanqing Advanced Institute of Economics and Finance and School of Finance, Renmin University of China, Beijing 100872, PR China |
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Abstract: | One distinguishable feature of storable commodities is that they relate to two markets: cash market and storage market. This paper proves that, if no arbitrage exists in the storage-cash dual markets, the commodity convenience yield has to be non-negative. However, classical reduced-form models for futures term structures could allow serious arbitrages due to the high volatility of the convenience yield. To avoid negative convenience yield, this paper proposes a semi-affine arbitrage-free model, which prices futures analytically and fits futures term structures reasonably well. Importantly, our model prices commodity-related contingent claims (such as calendar spread options) quite differently with classical models. |
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Keywords: | G12 G13 |
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