The Economicjournal

Hence the model explains changes in asset prices in terms of'fundamentals', i.e. changes in expected future payoffs (̂ (+<) or discount rates {8). Most tests ofthe model have used data for stocks, where the payoffs are dividends, or bonds, where the payoffs are interest and principal payments. These tests have had mixed outcomes, due in part to statistical and data problems.^ This paper explores the limits ofthe present value model by testing its ability to explain the pricing of storable commodities. Applying the present value model to commodities is useful for a number of reasons. First, the model is helpful in understanding price movements, and lets us test the rationality of commodity pricing in a way that is very different from earlier tests. Second, these tests provide evidence of the robustness of the present value model. (If the model is valid, it should explain the pricing of any asset that yields a payoff stream.) Third, if the commodity is traded on a futures market, the model can be written entirely in terms of spot and futures prices, and provides a parsimonious description of rational price dynamics. For a storable commodity, the payoff stream tjr^ is the convenience yield that accrues from holding inventories, i.e. the value of any benefits that inventories provide, including the ability to smooth production, avoid stockouts, and facilitate the scheduling of production and sales. Convenience yield is the