Commodity Derivatives Pricing with an Endogenous Convenience Yield Market Price of Risk
Posted: 9 Nov 2008 Last revised: 17 Sep 2010
Date Written: November 8, 2008
We develop a partial equilibrium model of the term structure of storable commodity futures and options on futures, where the stochastic movements of the convenience yield as well as those of interest rates and risk premia of primitives assets are considered. However, contrary to the existing literature, the risk premium of the convenience yield is derived endogenously. This framework is suited to the analysis of the impact of agent preference structure and investment horizon, along with other relevant state variables, on the convenience yield premium. Finally, closed form solutions for the prices of futures and options on futures are obtained, making our model suitable for commodity risk management.
Keywords: Commodities, convenience yield, market price of risk, futures, options
JEL Classification: G33, G12, G13
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