Economic Linkages, Relative Scarcity, and Commodity Futures Returns

50 Pages Posted: 26 Nov 2008 Last revised: 31 Mar 2020

See all articles by Jaime Casassus

Jaime Casassus

Pontificia Universidad Catolica de Chile

Peng Liu

Cornell University - S.C. Johnson College of Business - School of Hotel Administration

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University

Date Written: July 27, 2012

Abstract

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 not only on its own scarcity level, but also on its relative scarcity with respect to other economically-related commodities. This result implies a positive feedback effect from one commodity to another that is necessary to replicate the upward-sloping correlation term structure of futures returns observed from the related commodities. Our empirical Multi-Commodity Feedback Affine model (MCFA) allows for a flexible correlation term structure and validates our theoretical prediction. An out-of-sample test using short-maturity crack spread options data shows that our model considerably reduces the pricing error generated by traditional models.

Keywords: commodity futures, economic linkages, relative scarcity, correlation term structure, convenience yields, spread options

JEL Classification: C0, G12, G13, D51, D81, E2

Suggested Citation

Casassus, Jaime and Liu, Peng and Tang, Ke, Economic Linkages, Relative Scarcity, and Commodity Futures Returns (July 27, 2012). Available at SSRN: https://ssrn.com/abstract=1306022 or http://dx.doi.org/10.2139/ssrn.1306022

Jaime Casassus

Pontificia Universidad Catolica de Chile ( email )

Av. Vicuna Mackenna 4860
Instituto de Economia
Santiago
Chile
(56-2) 2354 4319 (Phone)

HOME PAGE: http://economia.uc.cl/profesor/jaime-casassus/

Peng Liu (Contact Author)

Cornell University - S.C. Johnson College of Business - School of Hotel Administration ( email )

448 Statler Hall
Ithaca, NY 14853
United States
6072542960 (Phone)

Ke Tang

Institute of Economics, School of Social Sciences, Tsinghua University ( email )

No.1 Tsinghua Garden
Beijing, 100084
China

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