RFS Advance Access originally published online on May 10, 2009
Review of Financial Studies 2009 22(11):4423-4461; doi:10.1093/rfs/hhp036
| ||||||||||||||||||||||||||||||||||||||||||||||||||
Unspanned Stochastic Volatility and the Pricing of Commodity Derivatives
Copenhagen Business School and Ecole Polytechnique Fédérale de Lausanne
UCLA Anderson School of Management and NBER
Send correspondence to Anders B. Trolle, Copenhagen Business School, Solbjerg Plads 3, A5, DK-2000 Frederiksberg, Denmark; telephone: +45-3815-3058. E-mail: abt.fi{at}cbs.dk.
JEL Classification: G13
 |
Abstract |
|---|
Commodity derivatives are becoming an increasingly important part of the global derivatives market. Here we develop a tractable stochastic volatility model for pricing commodity derivatives. The model features unspanned stochastic volatility, quasi-analytical prices of options on futures contracts, and dynamics of the futures curve in terms of a low-dimensional affine state vector. We estimate the model on NYMEX crude oil derivatives using an extensive panel data set of 45,517 futures prices and 233,104 option prices, spanning 4082 business days. We find strong evidence for two predominantly unspanned volatility factors.
We thank Michael Brennan, Peter Christoffersen, Pierre Collin-Dufresne, Alexander Eydeland, Hélyette Geman, Bjarne Astrup Jensen, Dev Joneja, Vassilis Koulovassilopoulos, David Lando, Claus Munk, Carsten Sørensen, and seminar participants at Bocconi University, Copenhagen Business School, University of Miami, Lehman Brothers, Natixis, the Commodities 2007 conference in London, the 2008 Nippon Finance Association meeting, and the 2008 European Finance Association meeting for comments. We are especially grateful for suggestions by Raman Uppal (the editor) and two anonymous referees that have improved the paper significantly. Anders B. Trolle thanks the Danish Social Science Research Council for financial support.