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A multifactor stochastic volatility model of commodity prices

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  • Cortazar, Gonzalo
  • Lopez, Matias
  • Naranjo, Lorenzo

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.

Suggested Citation

  • Cortazar, Gonzalo & Lopez, Matias & Naranjo, Lorenzo, 2017. "A multifactor stochastic volatility model of commodity prices," Energy Economics, Elsevier, vol. 67(C), pages 182-201.
    • Handle: RePEc:eee:eneeco:v:67:y:2017:i:c:p:182-201
    DOI: 10.1016/j.eneco.2017.08.007
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    Cited by:

    1. Tim Leung & Yang Zhou, 2021. "Optimal Dynamic Futures Portfolios Under a Multiscale Central Tendency Ornstein-Uhlenbeck Model," Papers 2102.12601, arXiv.org.
    2. Esposti, Roberto, 2021. "On the long-term common movement of resource and commodity prices.A methodological proposal," Resources Policy, Elsevier, vol. 72(C).
    3. Kang, Boda & Nikitopoulos, Christina Sklibosios & Prokopczuk, Marcel, 2020. "Economic determinants of oil futures volatility: A term structure perspective," Energy Economics, Elsevier, vol. 88(C).
    4. Ignatieva, Katja & Wong, Patrick, 2022. "Modelling high frequency crude oil dynamics using affine and non-affine jump–diffusion models," Energy Economics, Elsevier, vol. 108(C).
    5. Cortazar, Gonzalo & Naranjo, Lorenzo & Sainz, Felipe, 2021. "Optimal decision policy for real options under general Markovian dynamics," European Journal of Operational Research, Elsevier, vol. 288(2), pages 634-647.

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    More about this item

    Keywords

    Commodities; Multifactor models; Stochastic volatility; Derivatives;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • Q41 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Demand and Supply; Prices
    • C33 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Models with Panel Data; Spatio-temporal Models

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