Approximation for Convenience Yield with Mean-Reverting Commodity Price

Abstract

The convenience yield of commodities is an important factor influencing futures prices and its accurate measure is a hot issue. Standard option-based measures assume the commodity prices follow a geometric Brownian motion, while some empirical evidence supports that the commodity prices show mean-reverting properties. Using a mean-reverting price process, we derive an analytical convenience yield approximation. We use the soybean meal and strong wheat futures to compare the new measure with the existing approximations. Empirical study shows that the new method with the mean-reverting price process is a better approximation for convenience yields.