Pricing of Long-Dated Commodity Derivatives: Do Stochastic Interest Rates Matter?

38 Pages Posted: 25 Jan 2016 Last revised: 9 Nov 2020

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 25, 2016

Abstract

Does modelling stochastic interest rates, beyond stochastic volatility, improve pricing performance
on long-dated commodity derivatives? To answer this question, we consider futures
price models for commodity derivatives that allow for stochastic volatility and stochastic interest
rates and a correlation structure between the underlying variables. We examine the empirical pricing performance of these models on pricing long-dated crude oil derivatives. Estimating the model parameters from historical crude oil futures prices and option prices, we find that stochastic interest rate models improve pricing performance on long-dated crude oil derivatives, when the interest rate volatility is relatively high. Furthermore, increasing the model dimensionality does not tend to improve the pricing performance on long-dated crude oil option prices, but it matters for long-dated futures prices. We also find empirical evidence for a negative correlation between crude oil futures prices and interest rates that contributes to improving t to long-dated crude oil option prices.

Keywords: Futures options pricing, Stochastic interest rates, Correlations, Long-dated crude oil derivatives, commodity futures

JEL Classification: C13, C60, G13, Q40

Suggested Citation

Cheng, Benjamin and Sklibosios Nikitopoulos, Christina and Schloegl, Erik, Pricing of Long-Dated Commodity Derivatives: Do Stochastic Interest Rates Matter? (January 25, 2016). Journal of Banking and Finance, Vol. 95, 2018, Available at SSRN: https://ssrn.com/abstract=2721716 or http://dx.doi.org/10.2139/ssrn.2721716

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

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