A Generic Multi-Factor Model for Commodity Derivatives

Since commodity derivatives typically trade by futures (a.k.a. forwards), there is a need to model the dynamics of the forward curve. This article presents a generic multi-factor model for pricing commodity derivatives. Our theoretical results show that commodity prices are driven by multiple components. As such, the model can better capture the price dynamics and volatility smile/skew. Empirical study shows that the model prices are very close to the market prices, indicating prima facie that the model performs quite well