A multifactor stochastic volatility model of commodity prices

Gonzalo Cortazar; Matias Lopez; Lorenzo Naranjo

doi:10.1016/j.eneco.2017.08.007

A multifactor stochastic volatility model of commodity prices

Gonzalo Cortazar
, Matias Lopez
, Lorenzo Naranjo

Research output: Contribution to journal › Article › peer-review

19 Scopus citations

Abstract

We propose a novel representation of commodity spot prices in which the cost-of-carry and the spot price volatility are both driven by an arbitrary number of risk factors, nesting many existing specifications. The model exhibits unspanned stochastic volatility, provides simple closed-form expressions of commodity futures, and yields analytic formulas of European options on futures. We estimate the model using oil futures and options data, and find that the pricing of traded contracts is accurate for a wide range of maturities and strike prices. The results suggest that at least three risk factors in the spot price volatility are needed to accurately fit the volatility surface of options on oil futures, highlighting the importance of using general multifactor models in pricing commodity contingent claims.

Original language	English
Pages (from-to)	182-201
Number of pages	20
Journal	Energy Economics
Volume	67
DOIs	https://doi.org/10.1016/j.eneco.2017.08.007
State	Published - Sep 2017

Keywords

Commodities
Derivatives
Multifactor models
Stochastic volatility

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10.1016/j.eneco.2017.08.007

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title = "A multifactor stochastic volatility model of commodity prices",

abstract = "We propose a novel representation of commodity spot prices in which the cost-of-carry and the spot price volatility are both driven by an arbitrary number of risk factors, nesting many existing specifications. The model exhibits unspanned stochastic volatility, provides simple closed-form expressions of commodity futures, and yields analytic formulas of European options on futures. We estimate the model using oil futures and options data, and find that the pricing of traded contracts is accurate for a wide range of maturities and strike prices. The results suggest that at least three risk factors in the spot price volatility are needed to accurately fit the volatility surface of options on oil futures, highlighting the importance of using general multifactor models in pricing commodity contingent claims.",

keywords = "Commodities, Derivatives, Multifactor models, Stochastic volatility",

author = "Gonzalo Cortazar and Matias Lopez and Lorenzo Naranjo",

note = "Publisher Copyright: {\textcopyright} 2017 Elsevier B.V.",

year = "2017",

month = sep,

doi = "10.1016/j.eneco.2017.08.007",

language = "English",

volume = "67",

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T1 - A multifactor stochastic volatility model of commodity prices

AU - Cortazar, Gonzalo

AU - Lopez, Matias

AU - Naranjo, Lorenzo

PY - 2017/9

Y1 - 2017/9

N2 - We propose a novel representation of commodity spot prices in which the cost-of-carry and the spot price volatility are both driven by an arbitrary number of risk factors, nesting many existing specifications. The model exhibits unspanned stochastic volatility, provides simple closed-form expressions of commodity futures, and yields analytic formulas of European options on futures. We estimate the model using oil futures and options data, and find that the pricing of traded contracts is accurate for a wide range of maturities and strike prices. The results suggest that at least three risk factors in the spot price volatility are needed to accurately fit the volatility surface of options on oil futures, highlighting the importance of using general multifactor models in pricing commodity contingent claims.

AB - We propose a novel representation of commodity spot prices in which the cost-of-carry and the spot price volatility are both driven by an arbitrary number of risk factors, nesting many existing specifications. The model exhibits unspanned stochastic volatility, provides simple closed-form expressions of commodity futures, and yields analytic formulas of European options on futures. We estimate the model using oil futures and options data, and find that the pricing of traded contracts is accurate for a wide range of maturities and strike prices. The results suggest that at least three risk factors in the spot price volatility are needed to accurately fit the volatility surface of options on oil futures, highlighting the importance of using general multifactor models in pricing commodity contingent claims.

KW - Commodities

KW - Derivatives

KW - Multifactor models

KW - Stochastic volatility

UR - https://www.scopus.com/pages/publications/85033239671

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DO - 10.1016/j.eneco.2017.08.007

M3 - Article

AN - SCOPUS:85033239671

SN - 0140-9883

VL - 67

SP - 182

EP - 201

JO - Energy Economics

JF - Energy Economics

ER -

A multifactor stochastic volatility model of commodity prices

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Keywords

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