A two-factor cointegrated commodity price model with an application to spread option pricing

Walter Farkas, Elise Gourier, Robert Huitema and Ciprian Necula

Journal of Banking & Finance, 2017, vol. 77, issue C, 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.

Keywords: Commodities; Cointegration; Futures; Option pricing; Spread options; Spark spread; Crack spread (search for similar items in EconPapers)
JEL-codes: C61 G11 G12 (search for similar items in EconPapers)
Date: 2017
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Working Paper: A Two-Factor Cointegrated Commodity Price Model with an Application to Spread Option Pricing (2016)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jbfina:v:77:y:2017:i:c:p:249-268

DOI: 10.1016/j.jbankfin.2017.01.007

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