Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives

Anders B. Trolle and Eduardo S. Schwartz

No 12744, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We conduct a comprehensive analysis of unspanned stochastic volatility in commodity markets in general and the crude-oil market in particular. We present model-free results that strongly suggest the presence of unspanned stochastic volatility in the crude-oil market. We then develop a tractable model for pricing commodity derivatives in the presence of unspanned stochastic volatility. The model features correlations between innovations to futures prices and volatility, quasi-analytical prices of options on futures and futures curve dynamics in terms of a low-dimensional affine state vector. The model performs well when estimated on an extensive panel data set of crude-oil futures and options.

JEL-codes: G13 (search for similar items in EconPapers)
Date: 2006-12
New Economics Papers: this item is included in nep-ene and nep-ets
Note: AP
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Citations: View citations in EconPapers (1)

Published as Anders B. Trolle & Eduardo S. Schwartz, 2009. "Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 22(11), pages 4423-4461, November.

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