mapping commodity forward

[ajsa]

Hi David,

Generally speaking without considering convenience yield or storage, can we decompose a commodity forward into following?

1. short position of bond
2. buy underlying at spot price

Thanks.

 

[David Harper CFA FRM]

Hi ajsa,

Although Jorion says mapping a commodity forward is "substantially more complex" due to storage and convenience yield, if you want to abstract those out, then I see no problem with your approach. It's like an investment commodity forward where value = Spot - Delivery price * EXP[-rT], and that matches your mapping:

borrow cash (short bond) to buy the spot commodity

Thanks, David