Backwardation in oil futures markets: theory and empirical evidence

Article Abstract:

Oil futures prices are often below spot prices. This phenomenon, known as strong backwardation, is inconsistent with Hotelling's theory under certainty that the net price of an exhaustible resource rises over time at the rate of interest. We introduce uncertainty and characterize oil wells as call options. We show that (1) production occurs only if discounted futures are below spot prices, (2) production is non-increasing in the riskiness of future prices, and (3) strong backwardation emerges if the riskiness of future prices is sufficiently high. The empirical analysis indicates that U.S. oil production is inversely related and backwardation is directly related to implied volatility. (Reprinted by permission of the publisher.)

PETROLEUM AND COAL PRODUCTS, Petroleum, Petroleum and Coal Products Manufacturing, Analysis, Prices and rates, Futures market, Futures markets, Commodity futures, Futures, Spot market, Contango and backwardation

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Can costs of consumption adjustment explain asset pricing puzzles?

Article Abstract:

We investigate Grossman and Laroque's (1990) conjecture that costs of adjusting consumption can account, in part, for the empirical failure of the consumption-based capital asset pricing model (CCAPM). We incorporate small fixed costs of consumption adjustment into a CCAPM with heterogeneous agents. We find that undetectably small consumption adjustment costs can account for much of the discrepancy between the observed variance of nondurable aggregate consumption growth and the predictions of the CCAPM, and can partially reconcile nondurable consumption data with the observed equity premium. We conclude that the CCAPM's implications are nonrobust to extremely small adjustment costs. (Reprinted by permission of the publisher.)

Research, Consumption (Economics), Capital assets pricing model, Capital asset pricing model, Cost (Economics), Costs (Economics)

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