Convenience yield and the theory of storage: Applying an option-based approach

Akihiro Omura, Jason West

Research output: Contribution to journalArticle

7 Citations (Scopus)

Abstract

We propose that an options-based approach is a superior alternative to the traditional cost-of-carry method to model both the behaviour of convenience yields and the commodity price responses to changes in inventory levels. This approach is shown to be more robust and avoids the simplifying assumptions embedded in cost-of-carry valuation which fully accounts for the non-negativity constraint on inventory. Unlike the cost-of-carry approach, the options-based approach does not treat the convenience yield as an exogenous factor. This offers a more natural measure of implied convenience yields in commodity trading strategies. We test the relationship between convenience yields and inventory levels for a number of liquidly traded base metals using both methods. Our results show that the relationship between convenience yields and inventory levels is strongly defined under the options-based approach in line with market beliefs. This result is consistent with other studies that have used the options-based approach in other nonmetals commodity markets.

Original languageEnglish
Pages (from-to)355-374
Number of pages20
JournalAustralian Journal of Agricultural and Resource Economics
Volume59
Issue number3
DOIs
Publication statusPublished - 1 Jul 2015

Keywords

  • Base metals
  • Convenience yields
  • Cost of carry
  • Futures markets
  • Option pricing

Fingerprint Dive into the research topics of 'Convenience yield and the theory of storage: Applying an option-based approach'. Together they form a unique fingerprint.

  • Cite this