Title: Short-Term Variations and Long-Term Dynamics in Commodity Prices
Authors: Eduardo Schwartz University of California-Los Angeles and  James E. Smith Duke University
Date: April 22,1999 (first draft June 13, 1997)
Status: working paper

In this paper, we develop a two-factor model of commodity prices that allows mean-reversion in short-term prices and uncertainty in the equilibrium level to which prices revert.  Though these two factors are not directly observable, they may be estimated from spot and futures prices.  Intuitively, movements in prices for long-maturity futures contracts provides information about the equilibrium price level and differences between the prices for the short- and long-term contracts provides information about short-term variations in prices.  We estimate the parameters of the model using prices for oil futures contracts and show that, even though this model does not explicitly consider changes in "convenience yields" over time, this short-term/long-term model is equivalent to the stochastic convenience yield model developed in Gibson and Schwartz (1990).  We apply the model to some hypothetical oil-linked assets to demonstrate its use and some of its advantages over the Gibson-Schwartz model.

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