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Backwardation in Oil Futures Markets: Theory and Empirical Evidence

1995; Wiley; Volume: 50; Issue: 5 Linguagem: Inglês

10.2307/2329325

1540-6261

Robert H. Litzenberger, Nir Rabinowitz,

Capital Investment and Risk Analysis

The Journal of FinanceVolume 50, Issue 5 p. 1517-1545 Article Backwardation in Oil Futures Markets: Theory and Empirical Evidence ROBERT H. LITZENBERGER, ROBERT H. LITZENBERGERSearch for more papers by this authorNIR RABINOWITZ, NIR RABINOWITZ The Wharton School, University of Pennsylvania. We would like to thank Bruce Grundy for helpful discussions. We also acknowledge the comments of Erik Andersen, Sandy Grossman, Shmuel Kandel, Rich Kihlstrom, Srini Rangan, Rob Stambaugh, René Stulz (the editor) and an anonymous referee. We thank the seminar participants at the Wharton School, Tel-Aviv University, the 1993 WFA meetings and the 1994 AFA meetings for helpful comments.Search for more papers by this author ROBERT H. LITZENBERGER, ROBERT H. LITZENBERGERSearch for more papers by this authorNIR RABINOWITZ, NIR RABINOWITZ The Wharton School, University of Pennsylvania. We would like to thank Bruce Grundy for helpful discussions. We also acknowledge the comments of Erik Andersen, Sandy Grossman, Shmuel Kandel, Rich Kihlstrom, Srini Rangan, Rob Stambaugh, René Stulz (the editor) and an anonymous referee. We thank the seminar participants at the Wharton School, Tel-Aviv University, the 1993 WFA meetings and the 1994 AFA meetings for helpful comments.Search for more papers by this author First published: December 1995 https://doi.org/10.1111/j.1540-6261.1995.tb05187.xCitations: 161 Read the full textAboutPDF ToolsRequest permissionExport citationAdd to favoritesTrack citation ShareShare Give accessShare full text accessShare full-text accessPlease review our Terms and Conditions of Use and check box below to share full-text version of article.I have read and accept the Wiley Online Library Terms and Conditions of UseShareable LinkUse the link below to share a full-text version of this article with your friends and colleagues. Learn more.Copy URL Share a linkShare onEmailFacebookTwitterLinkedInRedditWechat 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. REFERENCES Black, F., 1976, The pricing of commodity contracts, Journal of Financial Economics 3, 167–179. Brennan, M. J., 1958, The supply of storage, American Economic Review 48, 50–72. Brennan, M. J., and E. Schwartz, 1985, Evaluating natural resource investments, Journal of Business 58, 135–157. Cox, J. C., J. E. Ingersoll, and S. A. Ross, 1981, The relation between forward prices and futures prices, Journal of Financial Economics 9, 321–346. Culp, M., and M. Miller, 1995, Metallgesellschaft and the economics of synthetic storage, Journal of Applied Corporate Finance 7, 62–76. Gibson, R., and E. Schwartz, 1990, Pricing of oil contingent claims, Journal of Finance 45, 959–976. Hansen, L. P., 1982, Large sample properties of generalized method of moment estimators, Econometrica 50, 1029–1054. Hotelling, H., 1931, The economics of exhaustible resources, Journal of Political Economy 39, 137–175. Jagannathan, R. K., 1984, Call options and the risk of underlying securities, Journal of Financial Economics 3, 425–434. Kaldor, N., 1939, Speculation and economic stability, Review of Economic Studies 7, 1–27. Merton, R. C., 1973, Theory of rational option pricing, Bell Journal of Economics and Management Science 4, 141–183. Miller, M. H., and C. W. Upton, 1985a, A test of the Hotelling valuation principle, Journal of Political Economy 93, 1–25. Miller, M. H., and C. W. Upton, 1985b, The pricing of oil and gas: Some further results, Journal of Finance 40, 1009–1018. Pindyck, R. S., 1980, Uncertainty and exhaustible resource markets, Journal of Political Economy 88, 1203–1225. Rothschild, M., and J. Stiglitz, 1970, Increasing risk: I. a definition, Journal of Economic Theory 2, 225–243. Sundaresan, S. M., 1984, Equilibrium valuation of natural resources, Journal of Business 57, 493–518. Tourinho, O. A., 1979, The valuation of reserves of natural resources: An option pricing approach, Unpublished doctoral dissertation, University of California, Berkeley. Working, H., 1948, Theory of the inverse carrying charge in futures markets, Journal of Farm Economics 30, 1–28. The Wharton School, University of Pennsylvania. Citing Literature Volume50, Issue5December 1995Pages 1517-1545 ReferencesRelatedInformation