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Option Pricing on Renewable Commodity Markets

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  • Jin, Na
  • Lence, Sergio H.
  • Hart, Chad E.
  • Hayes, Dermot J.

Abstract

Options markets on agricultural commodities with maturities that exceed 13 months seldom trade. Our hypothesis is that this market failure is due to the absence of an accurate option pricing model for commodities where mean reversion can be expected. Standard option pricing models assume proportionality between price variance and time to maturity. This proportionality is not a valid assumption for commodities where supply response works to bring prices back to production costs. The model suggests that traditional option pricing models will overprice long-term options on these markets.

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Bibliographic Info

Paper provided by Agricultural and Applied Economics Association in its series 2010 Annual Meeting, July 25-27, 2010, Denver, Colorado with number 60955.

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Date of creation: 2010
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Handle: RePEc:ags:aaea10:60955

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Keywords: commodity futures and option; price mean reverting; seasonality; Agricultural Finance; Financial Economics;

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  1. Bryan Routledge & Duane Seppi & Chester Spatt, . "Equilibrium Forward Curves for Commodities," GSIA Working Papers 1997-50, Carnegie Mellon University, Tepper School of Business.
  2. Bessembinder, Hendrik, et al, 1995. " Mean Reversion in Equilibrium Asset Prices: Evidence from the Futures Term Structure," Journal of Finance, American Finance Association, vol. 50(1), pages 361-75, March.
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