A hybrid commodity and interest rate market model

A joint model of commodity price and interest rate risk is constructed analogously to the multi-currency LIBOR Market Model (LMM). Going beyond a simple 're-interpretation' of the multi-currency LMM, issues arising in the application of the model to actual commodity market data are specifi...

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Bibliographic Details
Published inQuantitative finance Vol. 13; no. 4; pp. 543 - 560
Main Authors Pilz, K. F., Schlögl, E.
Format Journal Article
LanguageEnglish
Published Bristol Routledge 01.04.2013
Taylor & Francis Ltd
Subjects
Applied mathematical finance
Arbitrage pricing
Calibration of deterministic volatility
Commodity futures
Commodity markets
Commodity options
Commodity prices
Computational finance
Derivative pricing models
Interest rate derivatives
Interest rate modelling
Interest rate risk
Interest rates
LIBOR
Market prices
Spread
Studies
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Summary:A joint model of commodity price and interest rate risk is constructed analogously to the multi-currency LIBOR Market Model (LMM). Going beyond a simple 're-interpretation' of the multi-currency LMM, issues arising in the application of the model to actual commodity market data are specifically addressed. Firstly, liquid market prices are only available for options on commodity futures, rather than forwards, thus the difference between forward and futures prices must be explicitly taken into account in the calibration. Secondly, we construct a procedure to achieve a consistent fit of the model to market data for interest options, commodity options and historically estimated correlations between interest rates and commodity prices. We illustrate the model by an application to real market data and derive pricing formulas for commodity spread options.
ISSN:1469-7688
1469-7696
DOI:10.1080/14697688.2011.627879