Convenience yield and the theory of storage: applying an option‐based approach. (6th November 2014)

• Record Type: Journal Article
• Authors: Omura, Akihiro; West, Jason
• Is Part Of: Australian journal of agricultural and resource economics. Volume 59:Number 3(2015:Jul.)
• Page Start: 355
• Page End: 374
• Publication Date: 2014-11-06
• Subjects: Agriculture -- Economic aspects -- Periodicals; Agriculture -- Environmental aspects -- Periodicals; Natural resources -- Periodicals; Agriculture -- Economic aspects -- Australia -- Periodicals; Natural resources -- Australia -- Periodicals; 338.1
• DOI: 10.1111/1467-8489.12092
• Languages: English
• ISSNs: 1364-985X

Abstract

<abstract abstract-type="main" id="ajar12092-abs-0001"> <title> <x xml:space="preserve">Abstract</x> </title> <p>We propose that an options‐based approach is a superior alternative to the traditional cost‐of‐carry method to model both the behaviour of convenience yields and the commodity price responses to changes in inventory levels. This approach is shown to be more robust and avoids the simplifying assumptions embedded in cost‐of‐carry valuation which fully accounts for the non‐negativity constraint on inventory. Unlike the cost‐of‐carry approach, the options‐based approach does not treat the convenience yield as an exogenous factor. This offers a more natural measure of implied convenience yields in commodity trading strategies. We test the relationship between convenience yields and inventory levels for a number of liquidly traded base metals using both methods. Our results show that the relationship between convenience yields and inventory levels is strongly defined under the options‐based approach in line with market beliefs. This result is consistent with other studies that have used the options‐based approach in other nonmetals commodity markets.</p> </abstract>