The Stochastic Behavior of Commodity Prices with Heteroskedasticity in the Convenience Yield

26 Pages Posted: 25 Mar 2008 Last revised: 18 Dec 2010

See all articles by Peng Liu

Peng Liu

Cornell University - S.C. Johnson College of Business - School of Hotel Administration

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University

Date Written: November 1, 2008

Abstract

We document a new stylized fact regarding the dynamics of the commodity convenience yield: the volatility of the convenience yield is heteroskedastic for industrial commodities; specically, the volatility (variance) of the convenience yield depends on the convenience yield level. To explore the economic and statistical signicance of the improved specication of the convenience yield process, we propose an affine model with three state variables (log spot price, interest rate, and the convenience yield). Our model captures three important features of commodity futures the heteroskedasticity of the convenience yield, the positive relationship between spot-price volatility and the convenience yield and the dependence of futures risk premium on the convenience yield. Moreover our model predicts an upward sloping implied volatility smile, commonly observed in commodity option market.

Keywords: commodity, convenience yield, heteroskedasticity, affine models, volatility smile

JEL Classification: G13

Suggested Citation

Liu, Peng and Tang, Ke, The Stochastic Behavior of Commodity Prices with Heteroskedasticity in the Convenience Yield (November 1, 2008). Journal of Empirical Finance, Forthcoming, Available at SSRN: https://ssrn.com/abstract=1108594

Peng Liu (Contact Author)

Cornell University - S.C. Johnson College of Business - School of Hotel Administration ( email )

448 Statler Hall
Ithaca, NY 14853
United States
6072542960 (Phone)

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University ( email )

No.1 Tsinghua Garden
Beijing, 100084
China

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