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Economic Linkages, Relative Scarcity, and Commodity Futures Returns

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  • Jaime Casassus
  • Peng Liu
  • Ke Tang

Abstract

This paper shows that economic linkages among commodities create a source of long-term correlation between futures returns. We extend the theory of storage to a multi-commodity level and find that the convenience yield of a commodity depends on its relative scarcity with respect to other related commodities. This implies a feedback effect between commodities that is necessary to replicate the upward-sloping correlation term structure of futures returns observed for related commodities. We present a multi-commodity affine model that validates our theoretical predictions and considerably reduces the pricing errors in out-of-sample crack spread options. The Author 2012. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.

Suggested Citation

  • Jaime Casassus & Peng Liu & Ke Tang, 2013. "Economic Linkages, Relative Scarcity, and Commodity Futures Returns," The Review of Financial Studies, Society for Financial Studies, vol. 26(5), pages 1324-1362.
    • Handle: RePEc:oup:rfinst:v:26:y:2013:i:5:p:1324-1362
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    File URL: http://hdl.handle.net/10.1093/rfs/hhs127
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