A Hybrid Commodity and Interest Rate Market Model

30 Pages Posted: 8 Dec 2009

See all articles by Kay F. Pilz

Kay F. Pilz

RIVACON

Erik Schlögl

University of Technology Sydney (UTS), Quantitative Finance Research Centre; University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management; Faculty of Science, Department of Statistics, University of Johannesburg; Financial Research Network (FIRN)

Date Written: November 11, 2009

Abstract

A joint model of commodity price and interest rate risk is constructed analogously to the multi-currency LIBOR Market Model (LMM). Going beyond a simple “re-interpretation” of the multi-currency LMM, issues arising in the application of the model to actual commodity market data are specifically addressed. Firstly, liquid market prices are only available for options on commodity futures, rather than forwards, thus the difference between forward and futures prices must be explicitly taken into account in the calibration. Secondly, we construct a procedure to achieve a consistent fit of the model to market data for interest options, commodity options and historically estimated correlations between interest rates and commodity prices. We illustrate the model by an application to real market data and derive pricing formulas for commodity spread options.

Keywords: Commodity modeling, LIBOR Market Model, commodity futures, interest rate risk, spread options

JEL Classification: G13

Suggested Citation

Pilz, Kay F. and Schloegl, Erik, A Hybrid Commodity and Interest Rate Market Model (November 11, 2009). Available at SSRN: https://ssrn.com/abstract=1520208 or http://dx.doi.org/10.2139/ssrn.1520208

Kay F. Pilz

RIVACON ( email )

Im Apfelgrund 4
Friedrichsdorf, 61381
Germany

HOME PAGE: http://www.rivacon.com

Erik Schloegl (Contact Author)

University of Technology Sydney (UTS), Quantitative Finance Research Centre ( email )

Ultimo
PO Box 123
Sydney, NSW 2007
Australia
+61 2 9514 2535 (Phone)

HOME PAGE: http://www.schlogl.com

University of Cape Town (UCT) - The African Institute of Financial Markets and Risk Management ( email )

Leslie Commerce Building
Rondebosch
Cape Town, Western Cape 7700
South Africa

Faculty of Science, Department of Statistics, University of Johannesburg ( email )

Auckland Park, 2006
South Africa

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

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