Smile Modelling in Commodity Markets

TL;DR

This paper introduces a stochastic-local volatility model tailored for commodity futures derivatives, enabling accurate and fast calibration to market data while incorporating market-specific trading and margining features.

Contribution

It presents a novel, parsimonious model that captures forward-curve and smile dynamics in commodity markets with efficient calibration methods.

Findings

Model accurately fits liquid market quotes

Calibration process is computationally efficient

Incorporates market-specific trading clauses and margining procedures

Abstract

We present a stochastic-local volatility model for derivative contracts on commodity futures able to describe forward-curve and smile dynamics with a fast calibration to liquid market quotes. A parsimonious parametrization is introduced to deal with the limited number of options quoted in the market. Cleared commodity markets for futures and options are analyzed to include in the pricing framework specific trading clauses and margining procedures. Numerical examples for calibration and pricing are provided for different commodity products.