Alternative Models of Uncertain Commodity Prices for Use with Modern Asset Pricing Methods

Abstract

This paper provides an introduction to alternative models of uncertain commodity prices. A model of commodity price movements is the engine around which any valuation methodology for commodity production projects is built, whether discounted cash flow (DCF) models or the recently developed modern asset pricing (MAP) methods. The accuracy of the valuation is in part dependent on the quality of the engine employed. This paper provides an overview of several basic commodity price models and explains the essential differences among them. We also show how futures prices can be used to discriminate among the models and to estimate better key parameters of the model chosen.