An Empirical Analysis of Commodity Convenience Yields

Abstract

Driven by relative scarcity, convenience yields significantly impact risk management and (real) option valuation. We study the determinants of convenience yields using a unique dataset of inventories to proxy for relative scarcity. We find that convenience yields are negatively related to (discretionary) inventories. Marginal convenience yields plateau with a low supply/inventory for crude oil, but decline monotonically for copper and natural gas. Consistent with recent theory, inventory withdrawals are non-monotonically related to the convenience yield and they forecast significant futures returns. In addition, we test the effect of demand shocks on temporary and permanent price components. We show that the spot price-convenience yield correlation is time varying. Moreover, anticipated mean reversion and the spot price-convenience yield correlation both vary with relative scarcity. Our results suggest an exogenous price process distinct from those considered in earlier papers and which generates significantly different (real) option values.