The interest rate factor in commodity markets

Abstract

This paper proposes a joint affine term structure model for multiple commodity future contracts. We use latent variables as factors to find one common to the oil, corn, copper and gold markets. This common factor behaves like an interest rate, influencing futures prices through the cost of carry, and is consistent with the theory of storage. It approximates, but nevertheless significantly differs from, the US federal funds rate. Introducing it into a model that includes the federal funds rate significantly improves the fit of the joint affine commodity term structure model.

Keywords:

• Joint affine term structure model
• Commodity futures
• Common factor
• Kalman filter

JEL classification codes:

• G12
• G13
• G15

Acknowledgments

The author is grateful to Carol Alexander, Laura Coroneo, Adam Golinski, Alexandros Kostakis, Marcel Prokopczuk, Peter Smith, Peter Spencer and participants in the June 2017 4th Young Finance Scholars' Conference, University of Sussex for helpful comments.

Disclosure statement

No potential conflict of interest was reported by the author.