Commodity Price Behavior With Storage Frictions

Abstract

We present a competitive storage model of commodity prices featuring frictions that introduce an element of irreversibility into storage decisions. This leads to situations in which speculators do not trade in the spot market even though total storage is positive. As a result the market value of the stored commodity which is determined in the (financial) market for ownership of firms operating storage facilities can diverge from the spot price. Such price separation leads to the existence of an endogenous convenience yield which we show equals the expected excess return on a real option embedded in each unit of the stored commodity. The outputs of our model are consistent with the stylized facts regarding commodity price distributions including serial correlation and GARCH characteristics. Samuelson's hypothesis - that forward prices are less volatile than spot prices - does not hold in general.