New model to improve understanding of price dynamics in commodity markets

Based on models from the worlds of physics and mathematics, researchers will now develop a new model class for the empirically correct description of commodity market price dynamics. The interdisciplinary project has received DKK 3 million in funding from Aarhus University.

With funding of DKK 3 million from AU Ideas, a group of researchers from Aarhus University, Business and Social Sciences and Science and Technology are embarking on a project aimed at developing our mathematical understanding and studying the empirical relevance of a new type of stochastic models (models for presenting data or predicting outcomes that take some randomness into account - ed.). The so-called Ambit processes which have successfully been used for modelling turbulence in physics are ideal as price models and can be developed to help businesses improve their risk management in the commodity markets.

- The project will focus mainly on basic research and thus be aimed at developing the mathematical analysis of this model type and the econometric aspects necessitated by its practical application, explains Asger Lunde, Professor in Economics and head of the project.

He adds:

- In the long term, we expect the model to be used by businesses wanting to hedge future uncertainties about commodity prices. The model is expected to be useful to companies such as DONG Energy, Vestas and Mærsk as their daily operations are dependent on commodities trading.

Existing models not good enough
Models exist already which can be used for pricing in the commodity markets, but they are not good enough, especially in the electricity markets. According to Asger Lunde, the existing models are easy to use mathematically, but they do not factor in specific product characteristics:

- The existing models are designed to be simple to handle mathematically. They therefore do not take account of the way the trading is conducted in the markets and how agents react, explains Asger Lunde, adding:

- We want to develop a model class which is better at capturing the many different aspects of how the real markets work. We are working hard to get an idea about what it will look like.

Facts about the project:
- The project funding comes from AU Ideas, which is an initiative launched by the Aarhus University Research Foundation and the university management and aimed at helping to mature visionary and original project ideas.

- The project involves researchers from the local CREATES and Thiele Centre, at present a total of ten people, including a number of PhD students.

- The purpose of the project is to develop the mathematical analysis of Ambit processes as well as the econometric aspects which will pave the way for their practical application to commodity prices.

- As part of the project, a large database has been acquired which contains information about all the transactions completed in the US futures markets since 1978,

- Two international postdoc researchers – from Finland and Japan – have already been taken on and will be working on the basic research aspects of the project. A workshop has been planned for the autumn, as well as a large conference later in the project period.

- The project will run for four years and is undertaken in partnership with a number of foreign universities. Specific projects have already been launched which involve researchers from Heidelberg University, Oslo University and Imperial College London.

Further information:

 Asger Lunde

Asger Lunde, Professor in Economics
Aarhus University, Business and Social Sciences, CREATES

Department of Economics and Business:
Tel.: +45 8716 5297
Mobile: +45 5190 0977