Short-term variations and long-term dynamics in commodity prices

In this article, we develop a two-factor model of commodity prices that all ows mean-reversion in short-term prices and uncertainty in the equilibrium level to which prices revert. Although these two factors are not directly o bservable, they may be estimated from spot and futures prices. Intuitively, movements in prices for long-maturity futures contracts provide informatio n about the equilibrium price level, and differences between the prices for the short- and long-term contracts provide information about short-term va riations in prices. We show that, although this model does not explicitly c onsider changes in convenience yields over time, this short-term/long-term model is equivalent to the stochastic convenience yield model developed in Gibson and Schwartz (1990). We estimate the parameters of the model using p rices for oil futures contracts and apply the model to some hypothetical oi l-linked assets to demonstrate its use and some of its advantages over the Gibson-Schwartz model.