Essays on commodity and foreign exchange derivatives

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Abstract

This thesis consists of three essays on commodity and foreign exchange derivatives. Chapter 2 proposes a comprehensive option pricing model to capture stylized features in the energy commodity market. We use the Brent crude oil as a showcase and show that its implied volatility exhibits seasonal pattern and the skewness of its return distributions is time-varying. The option pricing model we proposed in this paper is able to capture these stylized features. The estimation results show that the model pricing performance for the crude oil options is significantly improved by capturing the time-varying skewness of return distributions, while there is no significant improvement by capturing the seasonal pattern in volatility.

Chapter 3 investigates the impact of speculative trading on the commodity futures risk premium. We focus on speculators' spread positions, and study the asset pricing implications of spreading pressure on the cross-section of commodity futures returns. In an era of financialization of commodity markets, a long-short portfolio based on the spreading pressure signal carries a significant risk premium. We show that spreading pressure reflects speculators' expectations about the change in the shape of the futures term structure, which is linked to commodity index investment. The spreading pressure factor can be explained by economic fundamentals and frictions introduced by financial traders.

Chapter 4 starts with risk-neutral probabilities of the Brexit referendum using data from both the options and prediction markets. We then provide a risk corrected measure of these probabilities using both non-parametric and parametric methods. While former correction marginally changes the risk-neutral probability, the performance of the latter depends on relative wealth calibration and risk preferences. We estimate subjective Brexit probabilities from past opinion polls and also provide daily estimates of voting intention to leave from BES survey. By comparing the subjective probabilities with our risk-corrected measures, our results show that both FX option and prediction market participants reveal moderate risk seeking preferences before the Brexit referendum.

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