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Valuing commodity options and futures options with changing economic conditions

Author

Listed:
  • Fan, Kun
  • Shen, Yang
  • Siu, Tak Kuen
  • Wang, Rongming

Abstract

A model for valuing a European-style commodity option and a futures option is discussed with a view to incorporating the impact of changing hidden economic conditions on commodity price dynamics. The proposed model may be thought of as an extension to the Gibson–Schwartz two-factor model, where the model parameters vary when the hidden state of an economy switches. A semi-analytical approach to valuing commodity options and futures options is adopted, where the closed-form expressions for the characteristic functions of the logarithmic commodity price and futures price are derived. A fast Fourier transform (FFT) approach is then applied to provide a practical and efficient way to evaluate the option prices. Real data studies and numerical examples are used to illustrate the practical implementation of the model.

Suggested Citation

  • Fan, Kun & Shen, Yang & Siu, Tak Kuen & Wang, Rongming, 2015. "Valuing commodity options and futures options with changing economic conditions," Economic Modelling, Elsevier, vol. 51(C), pages 524-533.
    • Handle: RePEc:eee:ecmode:v:51:y:2015:i:c:p:524-533
    DOI: 10.1016/j.econmod.2015.09.006
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    References listed on IDEAS

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    Full references (including those not matched with items on IDEAS)

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