Understanding the Non-Convergence of Agricultural Futures via Stochastic Storage Costs and Timing Options

TL;DR

This paper explains why futures prices sometimes do not converge to spot prices at maturity in the grains market by modeling stochastic storage costs and timing options, providing explicit pricing and empirical calibration.

Contribution

It introduces a novel stochastic storage cost model with optimal stopping strategies to explain non-convergence and derives explicit no-arbitrage prices for shipping certificates.

Findings

Model captures positive basis at maturity.

Calibrated to empirical data during non-convergence periods.

Highlights the premium of shipping certificates.

Abstract

This paper studies the market phenomenon of non-convergence between futures and spot prices in the grains market. We postulate that the positive basis observed at maturity stems from the futures holder's timing options to exercise the shipping certificate delivery item and subsequently liquidate the physical grain. In our proposed approach, we incorporate stochastic spot price and storage cost, and solve an optimal double stopping problem to give the optimal strategies to exercise and liquidate the grain. Our new models for stochastic storage rates lead to explicit no-arbitrage prices for the shipping certificate and associated futures contract. We calibrate our models to empirical futures data during the periods of observed non-convergence, and illustrate the premium generated by the shipping certificate.