Relative Scarcity of Commodities with a Long-Term Economic Relationship and the Correlation of Futures Returns

• Jaime Casassus ^[3] ; Peng Liu ^[1] ; Ke Tang ^[2]
  1. [1] Cornell University

     Cornell University

     City of Ithaca, Estados Unidos

     
  2. [2] Renmin University of China

     Renmin University of China

     China

     
  3. [3] Pontificia Universidad Catolica de Chile

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• Localización: Documentos de Trabajo ( Instituto de Economía PUC ), ISSN-e 0717-7593, Nº. 404, 2011, págs. 1-58
• Idioma: inglés
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• Resumen

  • This paper finds that the long-term co-movement of commodity prices is driven by economic relationships, such as production, substitution, and complementary relationships. Such relationships imply that the convenience yield of a given commodity depends on its relative scarcity with respect to associated commodities. The economic linkage between two commodities creates a new source of positive correlation between the futures returns of both commodities. We build an empirical, multi-commodity maximal affine model that allows the convenience yield of a commodity to depend on its relative scarcity. We estimate the model using three commodity pairs: heating oil-crude oil, WTI-Brent crude oil and heating oil-gasoline. Our model allows for a flexible correlation term structure of futures returns that matches the upward-sloping patterns observed in the data. The high long-term correlation implied by an economic relationship reduces the volatility of the spread between commodities, which implies lower spread option prices. An out-of-sample test using short-maturity crack spread options data shows that our model considerably reduces the negative bias generated by traditional models.