Valuation of Natural Resource Investments with Stochastic Convenience Yields and Interest Rates

We show how to apply the model of Miltersen and Schwartz (1997) to value natural resource investments. We derive a closed form solution for the value of a simple investment project in the presence of stochastic interest rates and convenience yields. This model takes into account a possible time lag between the investment decision date and the date when the commodity is ready to be sold in the market. We provide numerical examples with realistic parameter values showing that the presence of stochastic convenience yields has a significant impact on the value of the project. We also show how our approach can simplify the valuation of more complex natural resource investments.

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