Hey guys
Theory of Storage states that futures prices can be written this way:
Futures price = Spot price of the physical commodity + Direct storage costs (such as rent and insurance) – Convenience yield
Now, I understand that from the perspective of an arbitrageur or even a seller in general, a commodity would be priced based on how much it actually costs them.
However, I often cannot reconcile this theory with the fact that most financial instruments are valued/priced based on how much return they would generate rather than how much they would cost. Take stocks for example where we would compound it based on the required returns or if going by income approach use dividends (benefits) to value them in the present or future.
In terms of commodities, we kind of do the opposite. We add the costs and subtract the benefits. I understand why we do this. But I cannot reconcile this with the general financial theory of pricing based on benefits with those instruments paying the most being valued the most as well. In this case however, if a commodity pays the most (convenience yield) it is valued the least.