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Parametric Bootstrap Tests for Futures Price and Implied Volatility Biases with Application to Rating Livestock Margin Insurance for Dairy Cattle

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  • Bozic, Marin
  • Newton, John
  • Thraen, Cameron S.
  • Gould, Brian W.

Abstract

A common approach in the literature, whether the investigation is about futures price risk premiums or biases in option-based implied volatility coefficients, is to use samples in which consecutive observations can be regarded as uncorrelated. That will be the case for non- overlapping forecast horizons constructed by either focusing on short time-to-maturity contracts or excluding some data. In this article we propose a parametric bootstrap procedure for uncovering futures and options biases in data characterized by overlapping horizons and correlated prediction errors. We apply our method to test hypotheses that futures prices are efficient and unbiased predictors of terminal prices, and that squared implied volatility, multiplied by time left to option expiry, is an unbiased predictor of terminal log-price variance. We apply the test to corn, soybean meal and Class III milk futures and options data for the period 2000-2011. We find evidence for downward bias in soybean meal futures, as well as downward volatility bias in Class III milk options. Importance of these results is illustrated on the example of premium determination for Livestock Gross Margin Insurance for Dairy Cattle (LGM-Dairy).

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Bibliographic Info

Paper provided by University of Minnesota, Department of Applied Economics in its series Staff Papers with number 135077.

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Date of creation: Oct 2012
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Handle: RePEc:ags:umaesp:135077

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Related research

Keywords: parametric bootstrap; risk premium; volatility bias; revenue insurance; LGM-Dairy; Demand and Price Analysis; Research Methods/ Statistical Methods; Risk and Uncertainty;

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  1. Andrew McKenzie & Michael Thomsen & Josh Phelan, 2007. "How do you straddle hogs and pigs? Ask the Greeks!," Applied Financial Economics, Taylor & Francis Journals, vol. 17(7), pages 511-520.
  2. Brittain, Lee & Garcia, Philip & Irwin, Scott H., 2011. "Live and Feeder Cattle Options Markets: Returns, Risk, and Volatility Forecasting," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 36(1), April.
  3. Frank, Julieta & Garcia, Philip, 2005. "Time-Varying Risk Premium or Informational Inefficiency? Further Evidence in Agricultural Futures Markets," 2005 Conference, April 18-19, 2005, St. Louis, Missouri 19051, NCR-134 Conference on Applied Commodity Price Analysis, Forecasting, and Market Risk Management.
  4. Urcola, Hernan A. & Irwin, Scott H., 2011. "Are Agricultural Options Overpriced?," Journal of Agricultural and Resource Economics, Western Agricultural Economics Association, vol. 36(1), April.
  5. Thorsten M. Egelkraut & Philip Garcia & Bruce J. Sherrick, 2007. "The Term Structure of Implied Forward Volatility: Recovery and Informational Content in the Corn Options Market," American Journal of Agricultural Economics, Agricultural and Applied Economics Association, vol. 89(1), pages 1-11.
  6. Bozic, Marin & Newton, John & Thraen, Cameron S. & Gould, Brian W., 2012. "Mean-reversion in Income over Feed Cost Margins:Evidence and Implications for Managing Margin Risk by U.S. Dairy Producers," Staff Papers 132379, University of Minnesota, Department of Applied Economics.
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