The Stochastic Seasonal Behaviour of Natural Gas Prices

Abstract:     
Previous studies have explored the seasonal behaviour of commodity prices as a deterministic factor. This paper goes further by proposing a general (n+2m)‐factor model for the stochastic behaviour of commodity prices, which nests the deterministic seasonal model by Sorensen (2002). We consider seasonality as a stochastic factor, with n non‐seasonal and m seasonal factors. The non‐seasonal factors are as defined in Schwartz (1997), Schwartz and Smith (2000) and Cortazar and Schwartz (2003). The seasonal factors are trigonometric components generated by stochastic processes. The model has been applied to the Henry Hub natural gas futures contracts listed by NYMEX. We find that models allowing for stochastic seasonality outperform standard models with deterministic seasonality. We obtain similar results with other energy commodities. Moreover, we find that stochastic seasonality implies that the volatility of futures returns follows a seasonal pattern. This result has important implications in terms of option pricing.

Number of Pages in PDF File: 34

Keywords: stochastic calculus, seasonality, commodity prices, Kalman filter, natural gas

JEL Classification: C32, C51, C60, G13

Accepted Paper Series