No-Arbitrage Conditions for Storable Commodities and the Models of Futures Term Structures
Liu, Peng; Tang, Ke
One distinguishable feature of storable commodities is that they relate to two markets: cash market and storage market. This paper proves that, if no arbitrage exists in the storage-cash dual markets, the commodity convenience yield has to be non-negative. However, classical reduced-form models for futures term structures could allow serious arbitrages due to the high volatility of the convenience yield. To avoid negative convenience yield, this paper proposes a semi-affine arbitrage-free model, which prices futures analytically and fits futures term structures reasonably well. Importantly, our model prices commodity-related contingent claims (such as calendar spread options) quite differently with classical models.
No-arbitrage condition; exponential affine model; convenience yield; Kalman filter
Required Publisher Statement: © Elsevier. Final version published as: Liu, P., & Tang, K. (2010). No-arbitrage conditions for storable commodities and the models of futures term structures. Journal of Banking & Finance, 34(7), 1675-1687. doi:10.1016/j.jbankfin.2010.03.013Reprinted with permission. All rights reserved.