Risk Management in Commodity Markets

HELYETTE GEMAN is a Professor of Finance at Birkbeck, University of London and ESSEC Graduate Business School. She is a graduate of l’École Normale Supérieure in Mathematics, holds a Masters degree in Theoretical Physics and a PhD in Mathematics from the University Pierre et Marie Curie and a PhD in Finance from the University Panthéon Sorbonne. Professor Geman has been a scientific advisor to major financial institutions and energy and mining companies for the last 18 years, covering the spectrum of interest rates, catastrophic risk, oil, natural gas, electricity and metals. She was previously the head of Research and Development at Caisse des Dépôts. Professor Geman was the first president of the Bachelier Finance Society and has published more than 95 papers in top international finance Journals including the Journal of Finance, Journal of Financial Economics, Mathematical Finance. She is a Member of Honour of the French Society of Actuaries. Professor Geman's research includes interest rates and catastrophic insurance, asset price and commodity forward curve modelling, hedge funds and alternative investments, as well as exotic option pricing for which she won the first prize of the Merrill Lynch Awards in 1994. Her work on catastrophic options and CAT bonds and book Insurance and Weather Derivatives (1998) received the AFIR (actuarial approach to financial risk) prize.  Prof Geman was named in 2004 in the Hall of Fame of Energy Risk and received in July 2008 the ISA medal for Sciences of the Alma Mater University of Bologna for the CGMY model, a pure jump Levy process widely used in finance since 2002.Her reference book Commodities and Commodity Derivatives was published by Wiley Finance in January 2005. Professor Geman is a Member of the Board of the UBS-Bloomberger Commodity Index.

"... the wide range of issues covered in different ways should mean there is something for everyone." (Supply Management, February 5th 2009)

• Preface xiAbout the Editor xvAbout the Contributors xvii1 Structural Models of Commodity Prices 1Craig Pirrong, University of Houston1.1 Introduction 11.2 A Commodity Taxonomy 11.3 Fundamental Models for Storable Commodities 21.4 Non-Storable Commodities 61.5 Summary 71.6 References 72 Forward Curve Modelling in Commodity Markets 9Svetlana Borovkova, Universiteit Amsterdam, and Hélyette Geman, University of London and ESSEC2.1 Introduction 92.2 Forward Curve Models for Non-Seasonal Commodities 142.3 The Seasonal Forward Curve Model and its Extensions 172.4 Principal Component Analysis of a Forward Curve 242.5 Forward Curve Indicators 262.6 Conclusions 312.7 References 313 Integrating Physical and Financial Risk Management in Supply Management 33Paul R. Kleindorfer, University of Pennsylvania and INSEAD3.1 Introduction 333.2 A Primer On Previous Supply Management Contracting Literature 353.3 A Modelling Framework and a Simple Illustrative Case 373.4 Recent Contributions to the Optimal Contracting Literature 443.5 Some Open Research Questions and Implications for Practice 463.6 References 494 The Design of New Derivative Markets 51Giovanni Barone-Adesi, The Swiss Finance Institute and The University of Lugano4.1 Introduction 514.2 Determinants of Success of New Derivative Markets 524.3 Price Discovery 534.4 Trading, Clearing, and Margining 544.5 Market Integrity 554.6 Market Recovery 564.7 Market Oversight 564.8 Case Studies 574.9 Conclusion 584.10 References 585 Risk Premia of Electricity Futures: A Dynamic Equilibrium Model 61Wolfgang Bühler, University of Mannheim, and Jens Müller-Merbach, BHF-Bank Aktiengesellschaft5.1 Introduction 615.2 The Dynamic Equilibrium Model 625.3 Comparative Statics 645.4 Empirical Study 735.5 Conclusion 775.6 References 806 Measuring Correlation Risk for Energy Derivatives 81Roza Galeeva, Jiri Hoogland, and Alexander Eydeland, CMG, Morgan Stanley6.1 Introduction 816.2 Correlation 816.3 Perturbing the Correlation Matrix 826.4 Correlation VaR 856.5 Some Examples 856.6 Discussion and Conclusions 886.7 References 897 Precaution and a Dismal Theorem: Implications for Climate Policy and Climate Research 91Gary W. Yohe, Wesleyan University and Richard S. J. Tol, Economic and Social Research Institute, Dublin7.1 Introduction 917.2 A New Source of Concern: Weitzman’s Dismal Theorem 937.3 Implications of the “Dismal Theorem” 947.4 Some Concluding Remarks 967.5 References 978 Incentives for Investing in Renewables 101Falbo Paolo, University of Brescia, Felletti Daniele and Stefani Silvana, University of Milano Bicocca8.1 Introduction and Background 1018.2 Subsidies for Energy 1038.3 The Model 1048.4 Statistical Estimations 1078.5 Risk Analysis 1098.6 Conclusions 1148.7 References 1159 Hedging the Risk of an Energy Futures Portfolio 117Carol Alexander, ICMA Centre, University of Reading9.1 Mapping Portfolios to Constant Maturity Futures 1179.2 The Portfolio and its Key Risk Factors 1209.3 Identifying the Key Risk Factors 1239.4 Hedging the Portfolio Risk 1249.5 Conclusions 1279.6 References 12710 Spark Spread Options when Commodity Prices are Represented as Time Changed Processes 129Elisa Luciano, University of Turin10.1 Spark Spread Options 13010.2 Time Change in a Nutshell 13210.3 Time Change and Commodity Prices 13410.4 An Application to PJM Electricity and NYMEX Natural Gas 13710.5 Conclusions and Further Research 14410.6 Appendix A: Modelling Specification in the Multivariate Case 14510.7 Appendix B: Alternative Modelling Specifications in the Univariate Case 14710.8 References 15011 Freight Derivatives and Risk Management: A Review 153Manolis G. Kavussanos, Athens University of Economics and Business, and Ilias D. Visvikis, ALBA Graduate Business School, Athens11.1 Introduction 15311.2 Forward Freight Agreements 15411.3 Freight Futures 15711.4 “Hybrid” (Cleared) FFAs 16111.5 Freight Options 16211.6 Empirical Research on Freight Derivatives 16411.7 Conclusion 17811.8 References 17912 Mean-Reversion and Structural Breaks in Crude Oil, Copper, and Shipping 183Hélyette Geman, University of London and ESSEC Business School, and Steve Ohana, University of London12.1 Introduction 18312.2 Fundamentals of Copper, Crude Oil, and Shipping 18612.3 Defining Mean-Reversion 19112.4 Dataset and Unit Root Tests 19312.5 Conclusion 20312.6 References 20413 Managing Agricultural Price Risk in Developing Countries 207Julie Dana, The World Bank, and Christopher L. Gilbert, University of Trento and University of London13.1 The Liberalization Context 20713.2 Incidence of Risk Exposure 20913.3 Instruments and Problems 21513.4 Price Risk Management in the Developing Country Supply Chain 22113.5 Concluding Comments 23413.6 References 23614 Gaining Exposure to Emerging Markets in Institutional Portfolios: The Role of Commodities 239George A. Martin, Alternative Investment Analytics LLC and University of Massachusetts at Amherst, and Richard Spurgin, Clark University and Alternative Investment Analytics LLC14.1 Introduction 23914.2 Asset Markets and Economic Growth 23914.3 Are Emerging Markets Equity Markets and Commodity Markets Integrated? 24414.4 Implications for the Investment Policy of Institutional Investors 24714.5 Conclusion 25414.6 References 25415 Case Studies and Risk Management in Commodity Derivatives Trading 255Hilary Till, Premia Capital Management LLC15.1 Introduction 25515.2 Institutional Risk Management 25815.3 Proprietary-Trading Risk Management 26515.4 Hedge Fund Risk Management 26615.5 Fund-of-Hedge-Funds Diversification 26615.6 Market Risk Management 26715.7 Conclusion 28815.8 References 288Index 293