Commodity derivative valuation under a factor model with time-varying market prices of risk

It is well known that market prices of risk play an important role in commodity derivative valuation. There is an extensive literature showing that market prices of risk vary through time. Based on these results, a factor model, with two long- and short-term factors, with market prices of risk depen...

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Bibliographic Details
Published in:Review of derivatives research 2015-04, Vol.18 (1), p.75-93
Main Authors: Mirantes, Andrés G., Población, Javier, Serna, Gregorio
Format: Article
Language:English
Subjects:
Commodities
Commodity prices
Crude oil
Crude oil prices
Derivatives
Economics and Finance
Finance
Futures
Gasoline
Interest rates
Investments and Securities
Market prices
Maximum likelihood method
Natural gas
Put & call options
Risk
Standard deviation
Stochastic models
Studies
Valuation
Variables
Volatility
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Summary:It is well known that market prices of risk play an important role in commodity derivative valuation. There is an extensive literature showing that market prices of risk vary through time. Based on these results, a factor model, with two long- and short-term factors, with market prices of risk depending on these underlying asset factors is proposed and estimated, using data from crude oil, heating oil, unleaded gasoline and natural gas futures prices traded at NYMEX. The valuation results obtained with an extensive sample of commodity American options traded at NYMEX show that this model with time-varying market prices of risk outperforms standard models with constant market prices of risk.
ISSN:1380-6645
1573-7144
DOI:10.1007/s11147-014-9104-1