The Theory of Storage describes features observed in
commodity market
A commodity market is a market that trades in the primary economic sector rather than manufactured products, such as cocoa, fruit and sugar. Hard commodities are mined, such as gold and oil. Futures contracts are the oldest way of investin ...
s:
When available supplies of the commodity in question are high, and the working inventories of commercial consumers of that commodity are accordingly held to a minimum,
* Futures prices tend to be in
contango
Contango is a situation where the futures price (or forward price) of a commodity is higher than the ''expected'' spot price of the contract at maturity. In a contango situation, arbitrageurs or speculators are "willing to pay more owfor a comm ...
* The volatility of spot and futures prices tend to be low, and futures premiums rise to the full cost of storage
When supplies are tight, and purchasing managers build production inventory levels to ensure availability,
* Futures prices tend toward
backwardation
Normal backwardation, also sometimes called backwardation, is the market condition where the price of a commodity's forward or futures contract is trading below the ''expected'' spot price at contract maturity. The resulting futures or forward cu ...
* The volatility of cash and the nearby futures prices rises with respect to that of the more distant futures contracts
The theory of storage was originally developed and described by
Holbrook Working
Holbrook Working (February 5, 1895 – October 5, 1985) was an American professor of economics and statistics at Stanford University's Food Research Institute known for his contributions on hedging, on the theory of futures prices, on an early ...
in 1933.
[Working, H. 1933, "Price Relations between July and September Wheat Futures at Chicago Since 1885", Wheat Studies of the Food Research Institute.] It was extended by
Nicholas Kaldor
Nicholas Kaldor, Baron Kaldor (12 May 1908 – 30 September 1986), born Káldor Miklós, was a Cambridge economist in the post-war period. He developed the "compensation" criteria called Kaldor–Hicks efficiency for welfare comparisons (1939), d ...
in 1939 (who introduced the notion of
convenience yield
A convenience yield is an implied return on holding inventories. It is an adjustment to the cost of carry in the non- arbitrage pricing formula for forward prices in markets with trading constraints.
Let F_ be the forward price of an asset with i ...
), by Brennan in 1958 (who estimated demand and supply curves for storage), by Weymar in 1968 (who related convenience yield to the probability of inventory stockout) and by Schwartz in 1997 (modeling the yield as a mean-reverting stochastic process).
References
Economic theories
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