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Forward curves are typically built using market data from futures contracts or swaps. Prices for different maturities are plotted on a graph, with time on the x-axis and price on the y-axis. Interpolation and extrapolation techniques may be used to fill gaps or extend the curve beyond available data.
Common types include contango (future prices higher than spot) and backwardation (future prices lower than spot). These shapes reflect market expectations and can be influenced by factors like storage costs, interest rates, and supply-demand imbalances.
Forward curves allow risk managers to evaluate exposure to future price changes and assess the effectiveness of hedging strategies. They are used in value-at-risk (VaR) models, stress testing, and scenario analysis to quantify potential financial impacts.
In energy markets, forward curves often show seasonal patterns due to consumption cycles. In interest rate markets, they reflect monetary policy expectations. Each market has unique drivers, so curve shapes and construction methods vary accordingly.
