TSfit_volatility {NFCP} | R Documentation |
Calculate the volatility term structure of futures returns
Description
Estimate the theoretical and empirical volatility term structure of futures returns
Usage
TSfit_volatility(parameters, futures, futures_TTM, dt)
Arguments
parameters |
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futures |
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futures_TTM |
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dt |
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Details
The fit of an N-factor models theoretical volatility term structure of futures returns to those obtained directly from observed futures prices can be used as a measure of robustness for the models ability to explain the behaviour of a commodities term structure.
The theoretical model volatility term structure of futures returns is given by the following equation:
\[\sigma_F(\tau) = \sum_{i=1}^N \sum_{j=1}^N \sigma_i \sigma_j \rho_{i,j} e^{-(\kappa_i + \kappa_j)\tau}\]Under the case that \(\kappa_1 = 0\), the model volatility term structure converges to \(\sigma_1^2\) as \(\tau\) grows large.
The empirical volatility term structure of futures returns is given by:
\[\hat\sigma_F^2(\tau) = \frac{1}{\Delta t}\sum_{i=1}^N(log(F(t_i,\tau)/F(t_i-\Delta t,\tau)) - \bar\mu)^2\]According to Cortazar and Naranjo (2006): "A larger number of factors gives more flexibility to adjust first and second moments simultaneously, hence explaining why (a) four-factor (may) outperform (a) three-factor one in fitting the volatility term structure."
Value
TSfit_volatility
returns a matrix with the theoretical and empirical volatility term structure of futures returns, with the number of columns of this matrix coinciding with the number of input futures contracts.
References
Schwartz, E. S., and J. E. Smith, (2000). Short-Term Variations and Long-Term Dynamics in Commodity Prices. Manage. Sci., 46, 893-911.
Cortazar, G., and L. Naranjo, (2006). An N-factor Gaussian model of oil futures prices. Journal of Futures Markets: Futures, Options, and Other Derivative Products, 26(3), 243-268.
Examples
# Test the volatility term structure fit of the Schwartz-Smith two-factor model on crude oil:
V_TSFit <- TSfit_volatility(
parameters = SS_oil$two_factor,
futures = SS_oil$stitched_futures,
futures_TTM = SS_oil$stitched_TTM,
dt = SS_oil$dt)