Date of this Version
The Journal of Finance
We document a new stylized fact, that the relationship between the volatility of oil futures prices and the slope of the forward curve is nonmonotone and has a V-shape. This pattern cannot be generated by standard models that emphasize storage. We develop an equilibrium model of oil production in which investment is irreversible and capacity constrained. Investment constraints affect firms' investment decisions and imply that the supply elasticity changes over time. Since demand shocks must be absorbed by changes in prices or changes in supply, time-varying supply elasticity results in time-varying volatility of futures prices. Estimating this model, we show it is quantitatively consistent with the V-shape relationship between the volatility of futures prices and the slope of the forward curve.
This is the peer reviewed version of the following article, which has been published in final form at http://dx.doi.org/10.1111/j.1540-6261.2009.01466.x. This article may be used for non-commercial purposes in accordance with Wiley Terms and Conditions for Self-Archiving.
Kogan, L., Livdan, D., & Yaron, A. (2009). Oil Futures Prices in a Production Economy With Investment Constraints. The Journal of Finance, 64 (3), 1345-1375. http://dx.doi.org/10.1111/j.1540-6261.2009.01466.x
Date Posted: 27 November 2017
This document has been peer reviewed.