Modeling and estimating commodity prices: copper prices

Abstract

A new methodology is laid out for the modeling of commodity prices, it departs from the ‘standard’ approach in that it makes a definite distinction between the analysis of the short term and long term regimes. In particular, this allows us to come up with an explicit drift term for the short-term process whereas the long-term process is primarily driftless due to inherent high volatility of commodity prices excluding an almost negligible mean reversion term. Not unexpectedly, the information used to build the short-term process relies on more than just historical prices but takes into account additional information about the state of the market. This work is done in the context of copper prices but a similar approach should be applicable to wide variety of commodities although certainly not all since commodities come with very distinct characteristics. In addition, our model also takes into account inflation which leads us to consider a multi-dimensional system for which one can generate explicit solutions.