Equilibrium Exhaustible Resource Price Dynamics

Murray Carlson, Zeigham Khokher and Sheridan Titman

Journal of Finance, 2007, vol. 62, issue 4, 1663-1703

Abstract: We develop equilibrium models of exhaustible resource markets with endogenous extraction choices and prices. Our analysis demonstrates how adjustment costs can generate oil and gas forward price dynamics with two factors, consistent with the behavior these commodities exhibit in the Schwartz and Smith (2000) calibration. Our two‐factor model predicts that stochastic volatility will arise in these markets as a natural consequence of production adjustments, however, and we provide supporting empirical evidence. Differences between endogenous price processes from our general equilibrium model and exogenous processes in earlier papers can generate significant differences in both financial and real option values.

Date: 2007
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https://doi.org/10.1111/j.1540-6261.2007.01254.x

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Working Paper: Equilibrium Exhaustible Resource Price Dynamics (2006)
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