Exhaustible Resources with Adjustment Costs: Spot and Futures Prices

73 Pages Posted: 26 Sep 2019

See all articles by Min Dai

Min Dai

National University of Singapore (NUS) - Department of Mathematics

Steven Kou

Boston University

Cong Qin

Center for Financial Engineering

Date Written: September 25, 2019

Abstract

We propose an equilibrium model of exhaustible resources in a comprehensive setting, including exploration, stochastic demand, and stochastic reserve, by extending the models in Pindyck (1980) and Anderson, Kellogg, and Salant (2018). The production adjustments can be quite general, e.g., sudden or gradual changes of the instantaneous production level. The model has three advantages:

(1) It can generate low elasticity of production but high elasticity of exploration with respect to prices for general exhaustible resources (e.g., coal, natural gas, etc.).

(2) In terms of spot prices, the combination of exploration and adjustment costs can significantly prolong the period of time that a spot price stays at the bottom, which explains why spot prices of many commodities can be quite low for a long time.

(3) In terms of futures prices, the model can explain some stylized facts observed in futures markets, such as backwardation, contango, Samuelson effect, and higher volatility conditional on backwardation.

Keywords: Exhaustible Resources, Exploration, Production Adjustment Costs

JEL Classification: C61, C68, Q30, Q31

Suggested Citation

Dai, Min and Kou, Steven and Qin, Cong, Exhaustible Resources with Adjustment Costs: Spot and Futures Prices (September 25, 2019). Available at SSRN: https://ssrn.com/abstract=3459830 or http://dx.doi.org/10.2139/ssrn.3459830

Min Dai

National University of Singapore (NUS) - Department of Mathematics ( email )

Singapore

Steven Kou

Boston University ( email )

595 Commonwealth Avenue
Boston, MA 02215
United States
6173583318 (Phone)

Cong Qin (Contact Author)

Center for Financial Engineering ( email )

No. 1 Shizi Street, Center for Financial Engineeri
Suzhou, 215006
China
13656190706 (Phone)

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