Understanding the non-convergence of agricultural futures via stochastic storage costs and timing options

Abstract

This paper studies the market phenomenon of non-convergence between futures and spot prices in the grains market. We postulate that the positive basis observed at maturity stems from the futures holder's timing options to exercise the shipping certificate delivery item and subsequently liquidate the physical grain. In our proposed approach, we incorporate stochastic spot price and storage cost, and solve an optimal double stopping problem to give the optimal strategies to exercise and liquidate the grain. Our new models for stochastic storage rates lead to explicit no-arbitrage prices for the shipping certificate and associated futures contract. We calibrate our models to empirical futures data during the periods of observed non-convergence, and illustrate the premium generated by the shipping certificate.

How to mine gold without digging

“…For future research, a natural direction is to investigate if similar findings hold more generally by applying the same pricing model and estimation methodology to other commodity producers, such as oil, natural gas, agricultural products, and other precious metals. Other than working with the convenience yield model, it may be appropriate to consider mean-reverting models for some commodities and study the optimal production/investment strategies (Cortazar and Schwartz, 1997;Leung et al, 2014;Guo and Leung, 2017). Finally, our model can be applied to develop trading strategies that account for the factor loadings and alpha of gold miner equities, we can easily construct a market-neutral portfolio of gold miners to capture the idiosyncratic component of gold miner returns.…”

Approaches to Price Formation in Financialized Commodity Markets

“…The triangular relationship between spot, inventory and futures markets brings forth complex feedback mechanisms. Positive price trends in volatile markets can be intensified through inventory hoarding, either because inventories serve as physical options (Deaton and Laroque, ; Singleton, ; Guo and Leung, ), or because they are accumulated for precautionary reasons (Pindyck, ; Bozic and Fortenbery, ). While various models take these complex feedback mechanisms into consideration – see Gouel () – many of these models remain incomplete because futures markets are modelled as a reflection of dynamics in spot and inventory markets; for example Pindyck ().…”

Tracking VIX with VIX Futures: Portfolio Construction and Performance

“…However, market frictions, settlement rules 9 and non-tradability of the spot can substantially limit this convergence, as is seen in other futures markets, e.g. agricultural futures (Guo and Leung (2017)). For the non-convergence phenomenon of VIX futures, we refer to Pavlova and Daigler (2008) for an empirical study.…”