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A concrete model
Suitability for different commodities
Interaction with other assets
Alan Stacey
Motivation
A concrete model
Specifying the model
Semi-analytic approximation examples
Commodities Exotics
Model definition
Model properties
Sugar - 1Y expiry
Positive skew presented significant extra challenges to prevent
blow-up.
Measure suitability
Calibration Instruments
Intra-curve correlations
dF T = T (cos T dX + sin T dY ) .
For a more general case (i..e, not arising from a two-factor model)
we have
13 12 + 23 .
This is an easy exercise mathematically, and also has a
straightforward heuristic explanation.
We calibrate by taking three reasonably liquid tenors, e.g. 3M, 1Y,
3Y (commodity dependent) and then massaging the three pairwise
correlations so this inequality becomes an equality. We then
calibrate to fit these correlations.
How far this inequality deviates from equality is a good measure of
two-factorness.
Brent
Aluminium
Sugar
Sugar Calibration
Aluminium Calibration
Calibration Summary
So far we have only considered how well the model suits products
referencing a single commodity. But often we care about the
interaction between a commodity and another asset.
I quantos/compos - FX rates
I callables with a funding leg - interest rates
I baskets/worst-ofs - another commodity
As an illustration, we will consider the interaction between two
commodities.
Inter-commodity correlation
Simple models tend to assume that the correlation between two
commodities can be expressed by a single number.
Often this is the historical correlation between the spot or 1nb
(prompt contract) prices as these are most liquid.
But this can be very different from the correlation between long
ends of the curve.
Commodity 1 Commodity 2 Short-end corr 2Y Corr
Aluminium Soybeans 42% 49%
Aluminium Brent 53% 59%
Aluminium Gold 14% 24%
Soybeans Brent 36% 60%
Soybeans Gold 0.5% 57%
Brent Gold 33% 45%
A similar picture emerges even within commodities of the same
general class, e.g. agriculturals, softs, base metals.
Alan Stacey Commodities Modelling
Motivation
A concrete model
Suitability for different commodities
Interaction with other assets
Alumininum-Soybean
Alumininum-Brent
Brent-Gold