Economic Linkages, Relative Scarcity, and Commodity Futures Returns
Casassus, Jaime; Liu, Peng; Tang, Ke
This paper shows that economic linkages among commodities create a source of long-term correlation between futures returns. We extend the theory of storage to a multi-commodity level and find that the convenience yield of a commodity depends on its relative scarcity with respect to other related commodities. This implies a feedback effect between commodities that is necessary to replicate the upward-sloping correlation term structure of futures returns observed for related commodities. We present a multi-commodity affine model that validates our theoretical predictions and considerably reduces the pricing errors in out-of-sample crack spread options.
commodity futures; economic linkages; relative scarcity; correlation term structure; convenience yields; spread options
Casassus, J., Liu, P., & Tang, K. (2013). Economic linkages, relative scarcity, and commodity futures returns. Review of Financial Studies, 26(5), 1324-1362. doi:10.1093/rfs/hhs127
Required Publisher Statement: © Oxford University Press. Final version published as: Casassus, J., Liu, P., & Tang, K. (2013). Economic linkages, relative scarcity, and commodity futures returns. Review of Financial Studies, 26(5), 1324-1362. doi:10.1093/rfs/hhs127 Reprinted with permission. All rights reserved.