Commodities
Overview
Commodities are a material good. Sometimes they represent a final good to be purchased and consumed,
other times that serve as inputs into
production
of other goods or services.
Commodities are traded in
markets
like any other economic good, and subject to the same laws of
supply and demand
Commodity Prices
Most commodities are not traded directly, rather commodities are traded using
futures and forwards.
This poses a bit of a challenge to conducting a typical time series analysis. The difficulty arises
due to the fact that each future (or forward) that is traded for a given commodity has a set maturity date.
Therefore, the price series for each future only exists between the first day of trading for that contract
and its maturity date. Of course, when any contracts expire, there will be other contracts still being
traded, however, the prices will be different. That means that in order to conduct a long term study
(for instance, measuring long term trends), the price series from multiple contracts need to be
stitched together.
One way to approach this task is convert each price stream into a series of returns. Then take todays prices
from a currently traded contract, and then calculate a set of theoretical prices by reversing the calculated
returns.
Commodity Derivatives
For the purposes of pricing derivatives, commodity prices are usually modeled as
geometric brownian motions
, the same as
for equities. That means that the frameworks for pricing commodity deriivatives is the same as that for equities.
However, commodities have a cost and a yield associated with holding them. That is, when one owns a commodity
(not a commodity derivative), one typically has to pay stoarge costs proportional to the amount of commodity held.
This is cost to holding the commodity.
In addition, there is generally thought to be a benefit to holding the
commodity, known as the convenience yield. The convenience yield is modeled as a monetary benefit that accrues to
the holder of the commodity. In real life, the yield is theorectical, that is, one does not typically receive actual
payments for holding a commodity, however, it is known that market players often prefer to have physical possession
of commodities, even if they dont plan to utilize those commodities for some time. That is, there is
a
utility to holding the commodity.
The net effect of the storage costs and convenience yield associated with a commodity is that commodity derivatives
are modeled just like equity derivatives, for equities that pay dividends. In this case, the appropriate
yield that is used in place of the dividend yield is the convenience yield minus the storage costs.
Modeling
