The Pricing and Economics of Commodity Futures

While stocks and bonds are valued based on the discounted present value of future cash flows, commodity futures prices demonstrate different pricing dynamics because they do not provide a claim on future cash flows; they provide a claim on a physical asset. Commodity futures prices are tied mathematically to the current price of physical commodities in the cash markets. In addition, futures prices are dependent upon the risk aversion of buyers and sellers of physical commodities. Depending on whether the buyer or seller is more risk averse and, therefore, more willing to hedge their commodity price exposure, commodity futures prices can exhibit an upward or downward sloping yield curve.