Time-varying long-run mean of commodity prices and the modeling of futures term structures

Abstract

The exploitation of the mean-reversion of commodity prices is important for inventory management, in ‡ation forecasting and contingent claim pricing. Bessembinder, Coughenour, Seguin and Smoller (1995) document the mean-reversion of commodity spot prices using futures term structure data; however, mean-reversion to a constant level is rejected in nearly all studies using historical spot price time series. This indicates that the spot prices revert to a stochastic long-run mean. By recognizing this, I propose a reduced-form model with the stochastic long-run mean as a separate factor. This model …ts the futures dynamics better than do classical models such as the Gibson-Schwartz (1990) model and the Casassus-CollinDufresne (2005) model with a constant interest rate. An application for option pricing is also presented in this paper.Please address any comments to Ke Tang, 512D Mingde Building, Renmin University of China, Beijing, 100872. Tel:+86 10 62519408; Email:ketang@ruc.edu.cn. I am grateful to two anonymous referees, whose comments and suggestions have greatly improved this paper.

Convenience yield in commodity price modeling: A regime switching approach

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Sub-national economic effects of the resources sector in Chile

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