Generic Forward Curve Dynamics for Commodity Derivatives

TL;DR

This paper introduces a comprehensive framework for modeling commodity forward curves, capturing multiple price components to improve the accuracy of price and volatility predictions, with empirical validation showing close alignment with market prices.

Contribution

The paper develops a novel, generic model for commodity forward curve dynamics that accounts for multiple underlying components, enhancing predictive accuracy.

Findings

Model prices closely match market prices

The framework effectively captures forward price dynamics

Improved volatility modeling for commodity derivatives

Abstract

This article presents a generic framework for modeling the dynamics of forward curves in commodity market as commodity derivatives are typically traded by futures or forwards. We have theoretically demonstrated that commodity prices are driven by multiple components. As such, the model can better capture the forward price and volatility dynamics. Empirical study shows that the model prices are very close to the market prices, indicating prima facie that the model performs quite well.