Risk Management in Commodity Markets

Preface xi About the Editor xv About the Contributors xvii 1 Structural Models of Commodity Prices 1 Craig Pirrong, University of Houston 1.1 Introduction 1 1.2 A Commodity Taxonomy 1 1.3 Fundamental Models for Storable Commodities 2 1.4 Non-Storable Commodities 6 1.5 Summary 7 1.6 References 7 2 Forward Curve Modelling in Commodity Markets 9 Svetlana Borovkova, Universiteit Amsterdam, and Hélyette Geman, University of London and ESSEC 2.1 Introduction 9 2.2 Forward Curve Models for Non-Seasonal Commodities 14 2.3 The Seasonal Forward Curve Model and its Extensions 17 2.4 Principal Component Analysis of a Forward Curve 24 2.5 Forward Curve Indicators 26 2.6 Conclusions 31 2.7 References 31 3 Integrating Physical and Financial Risk Management in Supply Management 33 Paul R. Kleindorfer, University of Pennsylvania and INSEAD 3.1 Introduction 33 3.2 A Primer On Previous Supply Management Contracting Literature 35 3.3 A Modelling Framework and a Simple Illustrative Case 37 3.4 Recent Contributions to the Optimal Contracting Literature 44 3.5 Some Open Research Questions and Implications for Practice 46 3.6 References 49 4 The Design of New Derivative Markets 51 Giovanni Barone-Adesi, The Swiss Finance Institute and The University of Lugano 4.1 Introduction 51 4.2 Determinants of Success of New Derivative Markets 52 4.3 Price Discovery 53 4.4 Trading, Clearing, and Margining 54 4.5 Market Integrity 55 4.6 Market Recovery 56 4.7 Market Oversight 56 4.8 Case Studies 57 4.9 Conclusion 58 4.10 References 58 5 Risk Premia of Electricity Futures: A Dynamic Equilibrium Model 61 Wolfgang Bühler, University of Mannheim, and Jens Müller-Merbach, BHF-Bank Aktiengesellschaft 5.1 Introduction 61 5.2 The Dynamic Equilibrium Model 62 5.3 Comparative Statics 64 5.4 Empirical Study 73 5.5 Conclusion 77 5.6 References 80 6 Measuring Correlation Risk for Energy Derivatives 81 Roza Galeeva, Jiri Hoogland, and Alexander Eydeland, CMG, Morgan Stanley 6.1 Introduction 81 6.2 Correlation 81 6.3 Perturbing the Correlation Matrix 82 6.4 Correlation VaR 85 6.5 Some Examples 85 6.6 Discussion and Conclusions 88 6.7 References 89 7 Precaution and a Dismal Theorem: Implications for Climate Policy and Climate Research 91 Gary W. Yohe, Wesleyan University and Richard S. J. Tol, Economic and Social Research Institute, Dublin 7.1 Introduction 91 7.2 A New Source of Concern: Weitzman’s Dismal Theorem 93 7.3 Implications of the “Dismal Theorem” 94 7.4 Some Concluding Remarks 96 7.5 References 97 8 Incentives for Investing in Renewables 101 Falbo Paolo, University of Brescia, Felletti Daniele and Stefani Silvana, University of Milano Bicocca 8.1 Introduction and Background 101 8.2 Subsidies for Energy 103 8.3 The Model 104 8.4 Statistical Estimations 107 8.5 Risk Analysis 109 8.6 Conclusions 114 8.7 References 115 9 Hedging the Risk of an Energy Futures Portfolio 117 Carol Alexander, ICMA Centre, University of Reading 9.1 Mapping Portfolios to Constant Maturity Futures 117 9.2 The Portfolio and its Key Risk Factors 120 9.3 Identifying the Key Risk Factors 123 9.4 Hedging the Portfolio Risk 124 9.5 Conclusions 127 9.6 References 127 10 Spark Spread Options when Commodity Prices are Represented as Time Changed Processes 129 Elisa Luciano, University of Turin 10.1 Spark Spread Options 130 10.2 Time Change in a Nutshell 132 10.3 Time Change and Commodity Prices 134 10.4 An Application to PJM Electricity and NYMEX Natural Gas 137 10.5 Conclusions and Further Research 144 10.6 Appendix A: Modelling Specification in the Multivariate Case 145 10.7 Appendix B: Alternative Modelling Specifications in the Univariate Case 147 10.8 References 150 11 Freight Derivatives and Risk Management: A Review 153 Manolis G. Kavussanos, Athens University of Economics and Business, and Ilias D. Visvikis, ALBA Graduate Business School, Athens 11.1 Introduction 153 11.2 Forward Freight Agreements 154 11.3 Freight Futures 157 11.4 “Hybrid” (Cleared) FFAs 161 11.5 Freight Options 162 11.6 Empirical Research on Freight Derivatives 164 11.7 Conclusion 178 11.8 References 179 12 Mean-Reversion and Structural Breaks in Crude Oil, Copper, and Shipping 183 Hélyette Geman, University of London and ESSEC Business School, and Steve Ohana, University of London 12.1 Introduction 183 12.2 Fundamentals of Copper, Crude Oil, and Shipping 186 12.3 Defining Mean-Reversion 191 12.4 Dataset and Unit Root Tests 193 12.5 Conclusion 203 12.6 References 204 13 Managing Agricultural Price Risk in Developing Countries 207 Julie Dana, The World Bank, and Christopher L. Gilbert, University of Trento and University of London 13.1 The Liberalization Context 207 13.2 Incidence of Risk Exposure 209 13.3 Instruments and Problems 215 13.4 Price Risk Management in the Developing Country Supply Chain 221 13.5 Concluding Comments 234 13.6 References 236 14 Gaining Exposure to Emerging Markets in Institutional Portfolios: The Role of Commodities 239 George A. Martin, Alternative Investment Analytics LLC and University of Massachusetts at Amherst, and Richard Spurgin, Clark University and Alternative Investment Analytics LLC 14.1 Introduction 239 14.2 Asset Markets and Economic Growth 239 14.3 Are Emerging Markets Equity Markets and Commodity Markets Integrated? 244 14.4 Implications for the Investment Policy of Institutional Investors 247 14.5 Conclusion 254 14.6 References 254 15 Case Studies and Risk Management in Commodity Derivatives Trading 255 Hilary Till, Premia Capital Management LLC 15.1 Introduction 255 15.2 Institutional Risk Management 258 15.3 Proprietary-Trading Risk Management 265 15.4 Hedge Fund Risk Management 266 15.5 Fund-of-Hedge-Funds Diversification 266 15.6 Market Risk Management 267 15.7 Conclusion 288 15.8 References 288 Index 293