A Multifactor Stochastic Volatility Model of Commodity Prices

60 Pages Posted: 20 Jul 2016

See all articles by Gonzalo Cortazar

Gonzalo Cortazar

Pontificia Universidad Catolica de Chile

Matias Lopez

University of California, Berkeley, Haas School of Business, Financial Engineering, Students; Pontifical Catholic University of Chile - Department of Industrial Engineering

Lorenzo Naranjo

University of Miami - Department of Finance

Date Written: July 2016

Abstract

We propose a novel representation of commodity spot prices in which the cost-of-carry and the spot price volatility are both driven by an arbitrary number of risk factors, nesting many existing specifications. The model exhibits unspanned stochastic volatility, provides simple closed-form expressions of commodity futures, and yields analytic formulas of European options on futures. We estimate the model using oil futures and options data, and find that the pricing of traded contracts is accurate for a wide range of maturities and strike prices. The results suggest that at least three risk factors in the spot price volatility are needed to accurately fit the volatility surface of options on oil futures, highlighting the importance of using general multifactor models in pricing commodity contingent claims.

Keywords: Commodities, Multifactor Models, Stochastic Volatility, Derivatives

JEL Classification: G13, Q02, C58

Suggested Citation

Cortazar, Gonzalo and Lopez, Matias and Naranjo, Lorenzo, A Multifactor Stochastic Volatility Model of Commodity Prices (July 2016). Available at SSRN: https://ssrn.com/abstract=2811860 or http://dx.doi.org/10.2139/ssrn.2811860

Gonzalo Cortazar

Pontificia Universidad Catolica de Chile ( email )

Departamento Ingenieria Industrial y de Sistemas
Av. Vicuna Mackenna 4860
Santiago
Chile

Matias Lopez

University of California, Berkeley, Haas School of Business, Financial Engineering, Students ( email )

2220 Piedmont Avenue
Berkeley, CA
United States

Pontifical Catholic University of Chile - Department of Industrial Engineering ( email )

Av. Vicuña Mackenna 4860
La Florida
Santiago, Metropolitana
Chile

Lorenzo Naranjo (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
305-284-9491 (Phone)

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