Working Paper: NBER ID: w11509
Authors: Leonid Kogan; Dmitry Livdan; Amir Yaron
Abstract: We document a new stylized fact regarding the term-structure of futures volatility. We show that\nthe relation between the volatility of futures prices and the slope of the term structure of prices is\nnon-monotone and has a "V-shape"'. This aspect of the data cannot be generated by basic models\nthat emphasize storage while this fact is consistent with models that emphasize investment\nconstraints or, more generally, time-varying supply-elasticity. We develop an equilibrium model in\nwhich futures prices are determined endogenously in a production economy in which investment is\nboth irreversible and is capacity constrained. Investment constraints affect firms' investment\ndecisions, which in turn determine the dynamic properties of their output and consequently imply\nthat the supply-elasticity of the commodity changes over time. Since demand shocks must be\nabsorbed either by changes in prices, or by changes in supply, time-varying supply-elasticity results\nin time-varying volatility of futures prices. Calibrating this model, we show it is quantitatively\nconsistent with the aforementioned "V-shape" relation between the volatility of futures prices and\nthe slope of the term-structure.
Keywords: Futures Prices; Investment Constraints; Volatility; Term Structure
JEL Codes: G12; G13
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investment constraints (G11) | Change in supply elasticity (H31) |
| Change in supply elasticity (H31) | Increased volatility of futures prices (G13) |
| Investment constraints (G11) | Increased volatility of futures prices (G13) |
| Slope of the term structure (E43) | Volatility of futures prices (G13) |