Journal Article

Short-Term Variations and Long-Term Dynamics in Commodity Prices

Smith, James E, Schwartz, Eduardo

2000

Overview

In this article, we develop a two-factor model of commodity prices that allows meanreversion in short-term prices and uncertainty in the equilibrium level to which prices revert. Although these two factors are not directly observable, they may be estimated from spot and futures prices. Intuitively, movements in prices for long-maturity futures contracts provide information about the equilibrium price level, and differences between the prices for the short- and long-term contracts provide information about short-term variations in prices. We show that, although this model does not explicitly consider changes in convenience yields over time, this short-term/long-term model is equivalent to the stochastic convenience yield model developed in Gibson and Schwartz (1990). We estimate the parameters of the model using prices for oil futures contracts and apply the model to some hypothetical oil-linked assets to demonstrate its use and some of its advantages over the Gibson-Schwartz model.

• Publisher: INFORMS,Institute for Operations Research and the Management Sciences
• Subject: Commodity prices / Contracts / Covariance matrices / Datasets / Dynamic models / Equilibrium / Equilibrium prices / Future / Futures / Futures contracts / Long term / Maturity / Oil price / Parametric models / Petroleum / Price levels / Price models / Price uncertainty / Price volatility / Prices / real options / Risk premiums / Short term / State estimation / stochastic dynamic model / Stochastic models / Studies / Uncertainty / Word meaning