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Estimating Early Exercise Premiums on Gold and Copper Options Using a Multifactor Model and Density Matched Lattices

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  • Jimmy E. Hilliard
  • Jitka Hilliard

Abstract

We use the standard geometric Brownian motion augmented by jumps to describe the spot underlying and mean regressive models of interest rates and convenience yields as state variables for gold and copper prices. Estimates of parameters of the diffusion processes are obtained by the Kalman filter. Using these estimates, jump parameters are estimated in the second stage by least squares. Early exercise premia on puts and calls are computed using a lattice with probabilities assigned by the density matching technique. We find that while deep in the money options have greater absolute early exercise premiums, the early exercise premium is roughly constant as a percent of option price. Our findings also confirm that gold behaves like an investment asset and copper behaves like a commodity.

Suggested Citation

  • Jimmy E. Hilliard & Jitka Hilliard, 2015. "Estimating Early Exercise Premiums on Gold and Copper Options Using a Multifactor Model and Density Matched Lattices," The Financial Review, Eastern Finance Association, vol. 50(1), pages 27-56, January.
    • Handle: RePEc:bla:finrev:v:50:y:2015:i:1:p:27-56
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    File URL: http://hdl.handle.net/10.1111/fire.12059
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    Cited by:

    1. Dong Zou & Pu Gong, 2017. "A Lattice Framework with Smooth Convergence for Pricing Real Estate Derivatives with Stochastic Interest Rate," The Journal of Real Estate Finance and Economics, Springer, vol. 55(2), pages 242-263, August.
    2. Moreno, Manuel & Novales, Alfonso & Platania, Federico, 2019. "Long-term swings and seasonality in energy markets," European Journal of Operational Research, Elsevier, vol. 279(3), pages 1011-1023.
    3. Tang, Chun-Hua, 2018. "Subjective value of the guarantees embedded in public cash-balance pension plans," Journal of Pension Economics and Finance, Cambridge University Press, vol. 17(2), pages 231-250, April.

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