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Jump Processes in Commodity Futures Prices and Options Pricing

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  • Jimmy E. Hilliard
  • Jorge A. Reis
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    Abstract

    Empirical evidence shows that log-return relatives on commodity futures prices are not normally distributed. This departure from normality seems to be caused by large price changes occurring in the commodity markets with the arrival of important new information. This suggests that a jump-diffusion model may be a plausible choice for modeling the stochastic process underlying commodity option prices. Merton (1976a) develops a jump-diffusion option pricing model assuming that jump risk is unsystematic. However, the jump-diffusion model developed by Bates (1991) is more appropriate for commodity option pricing since it allows jump risk to be systematic. In this article, recent transactions data on futures and futures options are used to test out-of-sample options using American versions of Black's diffusion and Bates's jump-diffusion models. The results show that Bates's model performs considerably better than Black's model. Jump-diffusion Asian option prices are also shown to differ considerably from geometric Brownian motion Asian option prices. Copyright 1999, Oxford University Press.

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    Bibliographic Info

    Article provided by Agricultural and Applied Economics Association in its journal American Journal of Agricultural Economics.

    Volume (Year): 81 (1999)
    Issue (Month): 2 ()
    Pages: 273-286

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    Handle: RePEc:oup:ajagec:v:81:y:1999:i:2:p:273-286

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    Cited by:
    1. Chen, Gang & Roberts, Matthew C. & Roe, Brian E., 2005. "Empirical Performance of Alternative Option Pricing Models for Commodity Futures Options," 2005 Annual meeting, July 24-27, Providence, RI 19183, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    2. Richards, Timothy J. & Manfredo, Mark R. & Sanders, Dwight R., 2002. "Weather Derivatives: Managing Risk With Market-Based Instruments," 2002 Conference, April 22-23, 2002, St. Louis, Missouri 19074, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    3. Turvey, Calum G., 2005. "Managing Food Industry Business and Financial Risks with Commodity-Linked Credit Instruments," 2005 International Congress, August 23-27, 2005, Copenhagen, Denmark 24525, European Association of Agricultural Economists.
    4. Jin, Yufei & Turvey, Calum G., 2004. "A General Approach To Valuing Commodity-Linked Bonds," 2004 Annual meeting, August 1-4, Denver, CO 20039, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    5. Schmit, Todd M. & Luo, Jianchuan & Conrad, Jon M., 2010. "Estimating the Influence of Ethanol Policy on Plant Investment Decisions: A Real Options Analysis with Two Stochastic Variables," Working Papers 126963, Cornell University, Department of Applied Economics and Management.
    6. Richards, Timothy J. & Nganje, William E. & Acharya, Ram N., 2008. "Hysterisis in Food Safety Investments," 110th Seminar, February 18-22, 2008, Innsbruck-Igls, Austria 49888, European Association of Agricultural Economists.
    7. Koekebakker, Steen & Lien, Gudbrand D., 2002. "Term Structure of Volatility and Price Jumps in Agricultural Markets - Evidence from Option Data," 2002 International Congress, August 28-31, 2002, Zaragoza, Spain 24874, European Association of Agricultural Economists.
    8. Chen, Gang & Roberts, Matthew C. & Roe, Brian E., 2005. "Forecasting Livestock Feed Cost Risks Using Futures and Options," 2005 Conference, April 18-19, 2005, St. Louis, Missouri 19048, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
    9. Pennings, Joost M.E. & Garcia, Philip, 2004. "Strategic Risk Management Behavior: What Can Utility Functions Tell Us?," 2004 Annual meeting, August 1-4, Denver, CO 20388, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    10. Richter, Martin & Sørensen, Carsten, 2002. "Stochastic Volatility and Seasonality in Commodity Futures and Options: The Case of Soybeans," Working Papers 2002-4, Copenhagen Business School, Department of Finance.
    11. Roberto Andreotti Bodra & Afonso De Campos Pint, 2014. "Modelo De Volatilidade Estocástica Com Saltos Aplicado A Commodities Agrícolas," Anais do XLI Encontro Nacional de Economia [Proceedings of the 41th Brazilian Economics Meeting] 142, ANPEC - Associação Nacional dos Centros de Pósgraduação em Economia [Brazilian Association of Graduate Programs in Economics].
    12. Benth, Fred Espen & Koekebakker, Steen, 2008. "Stochastic modeling of financial electricity contracts," Energy Economics, Elsevier, vol. 30(3), pages 1116-1157, May.
    13. Arnold, Tom, 2006. "Using GMM to flatten the option volatility smile," Research in International Business and Finance, Elsevier, vol. 20(1), pages 1-21, March.
    14. Lingfei Li & Vadim Linetsky, 2012. "Time-Changed Ornstein-Uhlenbeck Processes And Their Applications In Commodity Derivative Models," Papers 1204.3679, arXiv.org.
    15. Richards, Timothy J. & Manfredo, Mark R., 2003. "Infrequent Shocks and Rating Revenue Insurance: A Contingent Claims Approach," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 28(02), August.
    16. Tomek, William G. & Peterson, Hikaru Hanawa, 2000. "Risk Management in Agricultural Markets: A Survey," Staff Papers 121140, Cornell University, Department of Applied Economics and Management.
    17. Chen, Gang & Roberts, Matthew C. & Roe, Brian E., 2005. "Managing Livestock Feed Cost Risks Using Futures and Options," 2005 Annual meeting, July 24-27, Providence, RI 19399, American Agricultural Economics Association (New Name 2008: Agricultural and Applied Economics Association).
    18. Riley, John Michael & Anderson, John D., 2009. "Producer Perceptions of Corn, Soybean and Cotton Price Risk," 2009 Annual Meeting, January 31-February 3, 2009, Atlanta, Georgia 46865, Southern Agricultural Economics Association.

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