Oil futures prices in a production economy with investment constraints
Name
2008-003.pdf
Size
663.25 KB
Format
Adobe PDF
Checksum (MD5)
55723187de53c802460a3687a3b14805
Author(s)
Kogan, Leonid
Livdan, Dmitry
Yaron, Amir
Date Issued
2008
Publisher
MIT Center for Energy and Environmental Policy Research
Series/Report no.
MIT-CEEPR (Series) ; 08-003WP.
Abstract
We document a new stylized fact regarding the term structure of futures volatility. We show that the relationship between the volatility of futures prices and the slope of the term structure of prices is non-monotone and has a "V-shape." This aspect of the data cannot be generated by basic models that emphasize storage while this fact is consistent with models that emphasize the investment constraints or, more generally, time-varying supply-elasticity. We develop an equilibrium model in which futures prices are determined endogenously in a production economy in which investment is both irreversible and is capacity constrained. Investment constraints affect firms' investment decisions, which in turn determine the dynamic properties of their output and consequently imply that the supply-elasticity of the commodity changes over time. Since demand shocks must be absorbed either by changes in prices, or by changes in supply, time-varying supply-elasticity results in time-varying volatility of futures prices. Estimating this model, we show it is quantitatively consistent with the aforementioned "V-shape" relationship between the volatility of futures prices and the slope of the term structure.
Persistent DSpace Link
