Jump Diffusion Models and Commodity Futures Pricing

This study reexamines how jumps in commodity prices affect the valuation of futures and options. Contrary to existing models, the authors find that jumps impact both futures contracts and options, not just options. Using a multi-factor jump-diffusion model under a martingale framework, they derive closed-form solutions for pricing these instruments. The findings suggest that traditional futures pricing models underestimate the effect of rare, extreme market movements. This has significant implications for managing risk in commodity markets​.