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Economic Linkages, Relative Scarcity, and Commodity Futures Returns

Jaime Casassus1; Peng Liu2; Ke Tang3

1 Pontificia Universidad Católica de Chile · 2 Cornell University · 3 Renmin University of China

Review of Financial Studies 2013 open access

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.

DOI
10.1093/rfs/hhs127
Volume
26 (5)
Pages
1324-1362
Language
en
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