Convenience Yield-Based Pricing of Commodity Futures

Abstract

This paper proposes a convenience yield-based pricing for commodity futures, which embeds the incompleteness of commodity futures markets in convenience yield. By using the pricing method, we conduct empirical analyses of crude oil, heating oil, and natural gas futures traded on the NYMEX in order to assess the incompleteness of energy futures markets. We show that the fluctuation from incompleteness is partly owed to the fluctuation from convenience yield. In addition, it is shown that the additional Sharpe ratio, which represents the degree of market incompleteness and is also used for derivative pricing written on energy prices, is obtained from the NYMEX data. Then, we apply the implied market price of risk to the pricing of Asian call option on crude oil futures. As an empirical example, we try to compute the call option price using the parameters estimated from crude oil futures prices.