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Approximation for convenience yield in commodity futures pricing

✍ Scribed by Richard Heaney

Publisher
John Wiley and Sons
Year
2002
Tongue
English
Weight
109 KB
Volume
22
Category
Article
ISSN
0270-7314

No coin nor oath required. For personal study only.

✦ Synopsis

Abstract

The pricing of commodity futures contracts is important both for professionals and academics. It is often
argued that futures prices include a convenience yield, and this article uses a simple trading strategy to
approximate the impact of convenience yields. The approximation requires only three variablesβ€”underlying
asset price volatility, futures contract price volatility, and the futures contract time to maturity. The
approximation is tested using spot and futures prices from the London Metals Exchange contracts for copper,
lead, and zinc with quarterly observations drawn from a 25‐year period from 1975 to 2000. Matching
Euro‐Market interest rates are used to estimate the risk‐free rate. The convenience yield
approximation is both statistically and economically important in explaining variation between the futures price
and the spot price after adjustment for interest rates. Β© 2002 Wiley Periodicals, Inc. Jrl Fut Mark
22:1005–1017, 2002

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