Model specification analysis in the methanol markets

Mark Cummins, Andrea Bucca, Bernard Murphy

Abstract

ABSTRACT

Methanol is produced from synthesis gas and has many chemical applications, the most notable of which is formaldehyde production. Much literature exists on methanol and its production but, to the authors' knowledge, none exists on spot price behavior. This paper fills this gap with an analysis of the European and US markets. A model specification analysis is performed on a set of models that incorporate jumps and/or stochastic volatility. Formal tests find no statistical support in favor of the extended models over Black-Scholes. However, in general, these models match the historical moments much better. A stochastic volatility jump-diffusion model of Bates performs best. Modeling-related insights on fair valuation of embedded derivatives and front-office structuring of methanol-based derivatives are provided.