Effect of Term Structure Model of Futures Price on Procurement Policies

31 Pages Posted: 19 Oct 2011 Last revised: 29 Nov 2011

See all articles by Ankur Goel

Ankur Goel

Case Western Reserve University - Weatherhead School of Management

Genaro Gutierrez

University of Texas at Austin - Red McCombs School of Business

Date Written: October 18, 2011

Abstract

The commodity futures price information conveyed by organized exchanges can be used by commodity processors to improve their procurement process. A practical obstacle in the utilization of this information is that the maturity dates of the traded contracts on the exchange and the decision cycle of commodity processors are not synchronized. In this paper, we develop a modeling framework that incorporates the dynamically evolving futures prices to negotiate forward contracts with their supplier. In particular, the pricing of these forward contracts are critical when their delivery dates are not synchronized with the maturities of the futures contracts traded on the exchange. In addition, we propose a systematic approach to model the trade-offs involved in commodity procurement and to incorporate the latest market prices in the development of optimal procurement polices. To test our models we use two well known models of commodity prices with increasing levels of complexity and precision. We use historical futures prices from CBOT (Chicago Board of Trade) and NYMEX (New York Mercantile Exchange) for wheat and unleaded gasoline respectively, to fit the price model parameters, and to test the inventory model on actual out of sample market prices. Our findings suggest that significant benefits are derived from incorporating systematically the latest futures prices on price models of increased precision.

Keywords: Stochastic price models, Commodity markets, Inventory management, Marginal convenience yield

Suggested Citation

Goel, Ankur and Gutierrez, Genaro, Effect of Term Structure Model of Futures Price on Procurement Policies (October 18, 2011). McCombs Research Paper Series No. IROM-06-11, Available at SSRN: https://ssrn.com/abstract=1945770 or http://dx.doi.org/10.2139/ssrn.1945770

Ankur Goel (Contact Author)

Case Western Reserve University - Weatherhead School of Management ( email )

10900 Euclid Ave.
Cleveland, OH 44106-7235
United States

Genaro Gutierrez

University of Texas at Austin - Red McCombs School of Business ( email )

Austin, TX 78712
United States

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