Asymmetric volatility of basis and the theory of storage

The theory of storage states that the marginal convenience yield on inventory falls at a decreasing rate as inventory increases. Previous literature has tested this hypothesis using the so-called "direct test" approach, which employs a direct measurement of inventory levels, or the "indirect test" approach, which examines the relative variation of spot and futures prices and the relative variation of negative basis to positive basis as alternative proxies for inventory levels. The rationale behind the indirect test is based on the hypothesis that futures prices are less variable than spot prices when inventory is low, and have similar variability when inventory is high. The authors propose a "unified test" of the theory of storage that incorporates aspects of both direct and indirect tests in an ARMAX-asymmetric GARCH model framework. (C) 2005 Wiley Periodicals, Inc.