Volume 16 | Issue 4 | Article 3

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Calibration of a Commodity Price Model with Unobserved Factors: The Case of Real Estate Index Futures
Lindsay C. Baran, Richard J. Buttimer Jr., and Steven P. Clark (G11, G13)

In this paper we calibrate the two-factor commodity price model of Schwartz and Smith (2000) for application in the nascent real estate index derivatives market. New derivative products, such as the futures and options contracts based on the Case-Shiller real estate index traded on the Chicago Mercantile Exchange (CME), present several unique modeling challenges. For instance, the underlying spot prices are only observed when the indices are updated at the end of each month and even then with a two month lag. We combine a constrained maximum likelihood procedure with Kalman filtering to estimate the two unobserved factors of the model, the long-run equilibrium price, and short-run deviations from the equilibrium.