A convenience yield is an adjustment to the cost of carry in the non-arbitrage pricing formula for forward prices in markets with trading constraints.
Let be the forward price of an asset with initial price and maturity . Suppose that is the continuously compounded interest rate for one year. Then, the non-arbitrage pricing formula should be
However, this relationship does not hold in most commodity markets, partly because of the inability of investors and speculators to short the underlying asset, . Instead, there is a correction to the forward pricing formula given by the convenience yield . Hence
This makes it possible for backwardation to be observable.
Read more about Convenience Yield: Example, Why Should A Convenience Yield Exist?
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