Pricing of Long-Dated Commodity Derivatives with Stochastic Volatility and Stochastic Interest Rates

30 Pages Posted: 8 Jan 2016

See all articles by Benjamin Cheng

Benjamin Cheng

University of Technology Sydney (UTS), UTS Business School, Students

Christina Sklibosios Nikitopoulos

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

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: January 6, 2016

Abstract

Aiming to study pricing of long-dated commodity derivatives, this paper presents a class of models within the Heath, Jarrow, and Morton (1992) framework for commodity futures prices that incorporates stochastic volatility and stochastic interest rate and allows a correlation structure between the futures price process, the futures volatility process and the interest rate process. The functional form of the futures price volatility is specified so that the model admits finite dimensional realisations and retains affine representations, henceforth quasi-analytical European futures option pricing formulae can be obtained. A sensitivity analysis reveals that the correlation between the interest rate process and the futures price process has noticeable impact on the prices of long-dated futures options, while the correlation between the interest rate process and the futures price volatility process does not impact option prices. Furthermore, when interest rates are negatively correlated with futures prices then option prices are more sensitive to the volatility of interest rates, an effect that is more pronounced with longer maturity options.

Keywords: Futures options, Stochastic interest rates, Stochastic volatility, Correlations, Long-dated commodity derivatives

JEL Classification: C60, G13, Q40

Suggested Citation

Cheng, Benjamin and Sklibosios Nikitopoulos, Christina and Schloegl, Erik, Pricing of Long-Dated Commodity Derivatives with Stochastic Volatility and Stochastic Interest Rates (January 6, 2016). Available at SSRN: https://ssrn.com/abstract=2712025 or http://dx.doi.org/10.2139/ssrn.2712025

Benjamin Cheng

University of Technology Sydney (UTS), UTS Business School, Students ( email )

Sydney
Australia

Christina Sklibosios Nikitopoulos (Contact Author)

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

Erik Schloegl

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

Here is the Coronavirus
related research on SSRN

Paper statistics

Downloads
102
Abstract Views
1,274
rank
294,412
PlumX Metrics