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2 Ansichten40 SeitenConference Presentation on Model for Exotic Commodity Derivatives

Nov 30, 2017

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Conference Presentation on Model for Exotic Commodity Derivatives

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Conference Presentation on Model for Exotic Commodity Derivatives

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A concrete model

Suitability for different commodities

Interaction with other assets

Is a model for crude any use for coffee and

copper?

Alan Stacey

13th April 2011

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

Motivation

A concrete model

Specifying the model

Semi-analytic approximation examples

Calibrating the model

Measures of two-factorness

Accuracy of calibration

Other single commodity modelling idiosyncrasies

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

Commodities Exotics

management of structures such as:

I APOs (asian options)

I Barrier options and other autocallables e.g. TARS.

I Extendible swaps (callables)

I Basket options

I compo options and quantos

I barriers on worst-ofs (or, sometimes equivalently, best-ofs)

I More complex structured notes

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

underlyings, e.g. gold, WTI crude, sugar; but they exist with

virtually any exchange-traded commodity: its impossible to design

a separate model for every one

Commodities have characteristics which make their modelling

distinct from that of rates, equities, FX, credit...

I Scale-invariance with roughly log-normal evolution

I Can have pronounced skew in either direction

I Need to model dynamics of a curve with at least 2-3

significant principal components

I Other features common to some commodities, e.g.

seasonality.

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Nomura to illustrate the issues.

I Can give basic equations and intuition but not all the

implementation details for reasons of time.

I There are various enhancements to the model to handle

particular issues which I cant go into.

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Model definition

For the usual daily margined futures this must be a martingale in

the rolling money market account measure.

I We define dF (t,T )

F (t,T ) in terms of two SABR processes, one of

which drives the whole futures curve in parallel and the other

of which only drives the short end of the curve.

(Exact form of the equations omitted from this version of the

slides.)

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Model properties

I Two-factor behaviour: instantaneous correlation of different

parts of the futures curve is not 1.

I Volatility and intra-curve decorrelation tend to decrease with

time to expiry .

I Allows for skew/smile

I Permits a term structure of inter-curve correlation

I Scale-free (lognormal-type) behaviour.

But why exactly this form?

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

For example, why not a principal component analysis?

In rates it is common to propose a functional form for intra-curve

correlations (usually one that is theoretically impossible!), fit to

historical data, then take the leading principal components to get a

reduced factor model.

If one did this for commodities, the two leading components would

typically look something like our two components (once

orthogonalized) - this suggest the dynamics are realistic.

But Jar Kai, with stochastic volatility is tractable.

I We can take long (6M or 1Y) steps with virtually no loss of

accuracy.

I We have a semi-analytic approximation for Europeans

sufficiently accurate out to 3-5 years for calibration.

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Sugar - 1Y expiry

Positive skew presented significant extra challenges to prevent

blow-up.

Motivation

A concrete model Specifying the model

Suitability for different commodities Semi-analytic approximation examples

Interaction with other assets

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Measure suitability

I Are the local dynamics reasonable? Most obvious example of

unsuitability is power.

I Are key features neglected? e.g. seasonality.

I Does the model calibrate well to the market?

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Calibration Instruments

different strikes per futures contract (usually only one expiry,

shortly before that of the future itself).

The Jar Kai model has nine main parameters (plus kT s to

fine-tune the ATM volatilities). One approach is to throw all the

option prices into the pot and use a least-squares optimizer.

Indeed, some people do this. But it is very unstable.

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Intra-curve correlations

dramatically with changes in parameters, mainly 2 and .

I However options prices do not vary much with 2 and , or

more precisely the option price fitting accuracy depends only

very weakly on 2 and .

I So we need to pin down intra-curve correlatons (and hence 2

and ) more directly.

I There are no liquid instruments to do this. (Brokers quotes

can sometimes be obtained for calendar spreads in very deep

markets like WTI).

I We use historical correlations.

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

given instant we may write, for any futures expiry T ,

dF T = T (cos T dX + sin T dY ) .

Given expiries T1 < T2 < T3 , writing corr(dF Ti , dF Tj ) = cos(ij ),

we have

13 = 12 + 23 .

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

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.

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Brent

6M1Y 99.3% 0.1184

1Y2Y 99.1% 0.1342

6M2Y 97.1% 0.2414 96.8% 98.4%

1M6M 99.0% 0.1415

6M2Y 97.1% 0.2414

1M2Y 94.6% 0.3301 92.8% 96.1%

WTI is more idiosyncratic than Brent, with a behaviour further

from a two-factor model. Why?

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Aluminium

6M1Y 99.9% 0.0447

1Y2Y 99.4% 0.1095

6M2Y 98.9% 0.1485 98.8% 99.3%

1M6M 99.8% 0.0633

6M2Y 98.9% 0.1485

1M2Y 98.3% 0.1847 97.8% 98.7%

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Sugar

6M12M 97.0% 0.244

12M17M 98.4% 0.180

6M17M 94.0% 0.348 91.1% 95.4%

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

ultimately fine-tuned using the kT s to match the ATM volatilities

precisely too, and fits other input option prices as well as possible

using a least-squares optimizer (this glosses over some tricky

details).

But one can still ask how good is the intra-curve fit. If is poor then

we can seem some extreme parameters which mean that

I Intra-curve correlations other than those input are not

well-fitted.

I Approximations which we rely on in simulation and calibration

are stretched to their limits .

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

WTI Calibration

Sugar Calibration

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Copper Calibration

Aluminium Calibration

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Calibration Summary

I The intra-curve decorrelation does not decay steadily with

expiry. Usually this occurs when the correlations are very high

at the short end.

I The smile has a lot of idiosyncratic structure.

I We need to fit the very short-dated smile accurately (while

maintaining vol-vol parameters that can be used at longer

maturities). Mean-reverting volatility performs better but is

harder. Jumps would be even better (as we all know).

Motivation Calibrating the model

A concrete model Measures of two-factorness

Suitability for different commodities Accuracy of calibration

Interaction with other assets Other single commodity modelling idiosyncrasies

Seasonality has various manifestations.

I Gas is hard to store and more expensive in the winter than the

summer. This is reflected in the forward curve and causes no

difficulty.

I Gas and some other fuels are prone to supply shortages in the

winter making them more volatile. The model can fit this (via

the kT s) but will try not to - it is under strain.

I Correlation between agricultural futures drops sharply across a

harvest. The model, with a time-homogeneous correlation

structure, cannot reflect this at all.

Precious metals, especially gold, trade in many ways like FX.

Standard FX-type barrier products on Gold will have tight prices

derived using PDE methods than this model cannot reproduce.

But for mixed-commodity baskets we dont have anything better.

Alan Stacey Commodities Modelling

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

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.

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

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

cross-commodity correlations.

The Jar Kai model is rich enough to have enough cross-factor

correlations to fit several inter-curve correlations. However,

sometimes it is necessary to make a heroic attempt to infer these

from just the short-end correlation. There is enough consistency of

behaviour between commodities to produce good results ... most

of the time!

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

Alumininum-Soybean

short long

short 42.3% 53.5%

long 43.0% 54.5%

short long

short 42.3% 50.1%

long 40.7% 48.8%

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

Alumininum-Brent

short long

short 53% 58%

long 54% 59%

short long

short 53% 59%

long 51% 59%

Motivation

A concrete model

Suitability for different commodities

Interaction with other assets

Brent-Gold

short long

short 33% 34%

long 36% 37%

short long

short 33% 48%

long 31% 45%

Alan Stacey Commodities Modelling

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