ABSTRACT
Brennan and Schwartz (1998) show the advantage of a dynamic investment strategy employing futures contracts that uses the predictability of asset returns for the equity and bond markets, as opposed to using futures to hedge underlying positions. e time varying nature of risk premia in commodity markets is justied by the predictability of commodity prices (Bessembinder and Chan 1992, Gorton et al. 2007, Hong and Yogo 2010). Our study then extends the analysis of Brennan et al. (1997) to commodity markets. To do so, we rely on the seminal works of Black (1976) and Gibson and Schwartz (1990), who adapt the theory of storage to the continuous time arbitrage free evaluation framework. We specically use an extension similar to that of Casassus and Collin-Dufresne (2005), which highlights the relevance of time-varying commodity risk premia for the valuation of commodity derivatives. eir framework uses the short rate, the spot commodity price and the convenience yield as predictive factors/state variables for the term structure of the commodity futures prices as well as for the term structure of interest rates. For equity, we use a simplied version of the model of Wachter (2002) with an ane market price of risk of the (log) equity price. e time-varying risk premium in the bond market is also considered in our setting as an ane function of the short rate (Dai and Singleton 2002, Duee 2002).
