Black to Negative: Embedded optionalities in commodities markets
Richard J. Martin, Aldous Birchall
TL;DR
This paper extends the Black model for commodities by explicitly modeling delivery liabilities, capturing the possibility of prices turning negative due to delivery failures.
Contribution
It introduces a simple generalization of the Black model that incorporates embedded optionalities related to delivery liabilities in commodity contracts.
Findings
The model accounts for negative prices caused by delivery issues.
It provides a framework to price commodities with delivery risk.
The approach enhances existing commodity pricing models.
Abstract
We address the modelling of commodities that are supposed to have positive price but, on account of a possible failure in the physical delivery mechanism, may turn out not to. This is done by explicitly incorporating a `delivery liability' option into the contract. As such it is a simple generalisation of the established Black model.
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Taxonomy
TopicsMarket Dynamics and Volatility · Stochastic processes and financial applications · Economic theories and models