Commodity price and volatility price models of Indonesia market

Abstract

Commodity markets in Indonesia have experienced a significant growth. Nowadays, commodities, e.g., palm oil and gold, are also traded in the exchange as financial instruments, i.e., futures contracts, as well as physical assets. Commodity price and volatility models are being crucial for forecasting the price and developing risk management tools. A stochastic model called the potential diffusion model is proven to be suitable to model the commodity price. In the spirit of market equilibrium, such a model is more realistic, even applied to the price with multiple attraction regions. The potential diffusion model can capture the characteristic behavior of the price. It can also be used to derive a volatility model, which is more realistic than a constant volatility assumed by most commodity models such as a geometric Brownian motion or a mean-reversion diffusion model. We applied the potential diffusion model to prices of commodities traded in Indonesia market. As a performance measure, we compare the distributional characteristics of the original price to those of simulated prices based on the potential diffusion model. For the volatility model, comparison is made between the daily volatilities based on the potential diffusion model and the historical volatilities.