Pricing of Long-dated Commodity Derivatives with Stochastic Volatility and Stochastic Interest Rates

Benjamin Cheng, Christina Nikitopoulos-Sklibosios () and Erik Schlogl
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Benjamin Cheng: Finance Discipline Group, UTS Business School, University of Technology Sydney, http://www.uts.edu.au/about/uts-business-school/finance

No 366, Research Paper Series from Quantitative Finance Research Centre, University of Technology, Sydney

Abstract: Aiming to study pricing of long-dated commodity derivatives, this paper presents a class of models within the Heath, Jarrow, and Morton (1992) framework for commodity futures prices that incorporates stochastic volatility and stochastic interest rate and allows a correlation structure between the futures price process, the futures volatility process and the interest rate process. The functional form of the futures price volatility is specified so that the model admits finite dimensional realisations and retains affine representations, henceforth quasi-analytical European futures option pricing formulae can be obtained. A sensitivity analysis reveals that the correlation between the interest rate process and the futures price process has noticeable impact on the prices of long-dated futures options, while the correlation between the interest rate process and the futures price volatility process does not impact option prices. Furthermore, when interest rates are negatively correlated with futures prices then option prices are more sensitive to the volatility of interest rates, an effect that is more pronounced with longer maturity options.

Keywords: futures options; stochastic interest rates; stochastic volatility; correlations; long-dated commodity derivatives (search for similar items in EconPapers)
JEL-codes: C60 G13 Q40 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2015-12-01
New Economics Papers: this item is included in nep-ore
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (6)

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