Humps in the Volatility Structure of the Crude Oil Futures Market: New Evidence

38 Pages Posted: 9 Oct 2012

See all articles by Carl Chiarella

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group

Boda Kang

Lacima Group

Christina Sklibosios Nikitopoulos

University of Technology Sydney - Business School; Financial Research Network (FIRN)

Thuy Duong To

University of New South Wales, Sydney; Financial Research Network (FIRN)

Date Written: April 3, 2012

Abstract

This paper analyzes the volatility structure of the commodity derivatives markets. The model encompasses stochastic volatility that may be unspanned by the futures contracts. A generalized hump-shaped volatility specification is assumed that entails a finite-dimensional affine model for the commodity futures curve and quasi-analytical prices for options on commodity futures. An empirical study of the crude oil futures volatility structure is carried out using an extensive database of futures prices as well as futures option prices spanning 21 years. The study supports hump-shaped, partially spanned stochastic volatility specification. Factor hedging, which takes into account shocks to both the volatility processes and the futures curve, depicts the out-performance of the hump-shaped volatility in comparison to the more popular exponential decaying volatility and the presence of unspanned components in the volatility of commodity futures.

Keywords: Commodity derivatives, Crude oil derivatives, Unspanned stochastic volatility, Hump-shaped volatility, Pricing, Hedging

Suggested Citation

Chiarella, Carl and Kang, Boda and Sklibosios Nikitopoulos, Christina and To, Thuy Duong, Humps in the Volatility Structure of the Crude Oil Futures Market: New Evidence (April 3, 2012). 29th International Conference of the French Finance Association (AFFI) 2012. Available at SSRN: https://ssrn.com/abstract=2083726 or http://dx.doi.org/10.2139/ssrn.2083726

Carl Chiarella

University of Technology, Sydney - UTS Business School, Finance Discipline Group ( email )

PO Box 123
Broadway, NSW 2007
Australia
+61 2 9514 7719 (Phone)
+61 2 9514 7711 (Fax)

HOME PAGE: http://www.business.uts.edu.au/finance/

Boda Kang (Contact Author)

Lacima Group ( email )

Sydney
Australia

Christina Sklibosios Nikitopoulos

University of Technology Sydney - Business School ( email )

15 Broadway, Ultimo
Sydney 2007, New South Wales
Australia

Financial Research Network (FIRN)

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

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

Thuy Duong To

University of New South Wales, Sydney ( email )

School of Banking and Finance,
University of New South Wales
Sydney, 2052
Australia
61295855865 (Phone)

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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