COMMODITY PRICE DYNAMICS ppt

[...]... perhaps higher moments) of the forward price of copper This means that options prices incorporate information about commodity price dynamics, and hence these options prices can be used to test predictions of commodity price models As discussed later, structural models for storable commodities also make predictions about the behavior of commodity inventories, that is, commodity stocks Indeed, the behavior... though there are commodity stocks, commodity forward prices behave differently from asset forward prices Whereas asset forward prices always reflect full carrying costs (the opportunity cost of capital net of the asset’s cash flow), commodity forward prices do not This distinction between a consumption good and a true asset has important implications for the possibility of bubbles in commodity prices, that... living producing or processing commodities Unfortunately, the modeling of commodity prices has not kept pace Most practitioners have adopted reduced-form models, such as the model that is the basis for the Black-Scholes option pricing formula, to analyze commodity prices and to price commodity derivatives Structural models of commodity prices that explicitly account for the implications of intertemporal... between futures prices on a particular commodity, with different delivery dates, or swaptions that are effectively options on the forward curve for a particular commodity It is well known that the prices of options depend on the characteristics of the dynamics of the underlying price, most notably on the volatility (and perhaps higher moments) of the underlying price Thus, a copper option’s price depends... abundant data on commodity futures prices for a wide variety of commodities Moreover, data on other commodity derivatives are becoming increasingly available Most notably, commodity options are more widely traded than ever, and hence option price data are becoming commonplace To exploit these data, the book focuses on the implications of structural commodity price models for the behavior of commodity spot... commodities These include: r How do commodity prices behave? r What does the forward curve for a commodity look like, and how does its shape change as fundamental economic conditions change? r How does the amount of a commodity stored change over time in response to fundamental economic conditions? r How do the higher moments of commodity prices behave? r How do commodity forward prices with different maturity... organized as follows 1.4.1 Modeling Storable Commodity Prices The received theory of storage, based on the stochastic dynamic programming rational expectations modeling framework, is an economically grounded approach for understanding how commodity prices behave and how fundamentals affect commodity prices This framework can be adapted to each particular commodity In this chapter, I review the basics... fundamentals-based model in which spot prices, and hence forward and options prices, depend on electricity demand and fuel prices I show how options prices vary systematically with fundamentals The chapter also shows that the market price of risk is an important determinant of electricity forward prices 1.5 Where This Book Fits in the Literature Serious academic attention to the issue of commodity pricing, and the... remaining futures prices These scholars do not examine the behavior of correlations between futures prices of different maturities Fama and French (1988) and Ng and Pirrong (1994, 1996) do not test a specific model of commodity prices but examine the implications of the convenience yield and structural models for the volatility of commodity prices, and the correlations between futures prices with different... someday replace reduced-form models as the preferred way to price commodity options of all types The third is policy makers Commodity prices have always been a bone of political contention, although the intensity of commodity- related controversies has waxed and waned over time The years since 2005 or so have been a time of waxing Commodity price spikes and crashes have sparked widespread condemnation . option pricing formula, to analyze commodity prices and to price commodity derivatives. Structural models of commodity prices that explicitly account for. explain salient features of commodity price dynamics. This is a finding that points out the value of looking at higher moments of prices and at the prices of derivatives