Abstract:
An investor in commodity markets is often faced with both price risk and currency risk, as the commodity is often traded in a different currency than the investor’s own. Often, the news report that the commodity prices and the USD/EUR rate move in opposite directions, indicating that the currency risk and price risk offsets each other for a Euro denominated investor. In this paper, I investigate if this is in fact the case and to which extent the correlation connects to the volatility of the commodity price and exchange rates. The paper introduces a model which allows for stochastic correlation of both signs and models the futures price curves and option prices in a model. The model is estimated using data on WTI crude oil and EURUSD futures contracts traded at the Chicago Merchantile Exchange from 1998 to 2013.