That's an interesting thought provoking approach. Luckily, we're not looking at any more negative prices for future deliveries, so for now, threat neutralized, but I would like to update my model for this if it happens again.Shifted Lognormal with lower bound = max storage cost?
The cost of storage is also variable. A shifted lognormal model with lower bound of say -30$/barrel would imply that the oil futures prices has low volatility in dollar terms as oil approaches -30, but in fact the $ volatility would be high in such an unusual situation. Look at how May WTI oil futures traded before expiring.That's an interesting thought provoking approach. Luckily, we're not looking at any more negative prices for future deliveries, so for now, threat neutralized, but I would like to update my model for this if it happens again.Shifted Lognormal with lower bound = max storage cost?
Hi! We've also come across Bachelier. Hoewever, does Cox-Ross-Rubinstein work in negative environment (both negative rates and negative prices)? Or does it also assume lognormality like BS (i.e. that prices cannot be negative)?Thanks. Yeah we will probably toggle to Bachelier when the situation arises.
For this particular application I am only looking to use a simple financial market model for a fair value approximation. However, I do agree with your assessment in general. The participants on this board all have different needs and levels of sophistication they are trying to achieve.A long time ago, I was encouraged to take on a leading quant role in one of the major financial players in the commodities market, with a particular strength in energy derivatives. I demurred on account that it would seem to be crazy to apply simple financial market models (that I knew something about) to things with finite supply, non-trivial storage cost, location specific pricing, no free disposal, and a small number of players with real market power. Seeing a discussion fifteen years later whether one should switch from Black to Bachelier after a $40 drop in the near WTI contract price suggests that a lot of thoughtless modeling is still going on in this space.