Three essays in commodity futures and options price performance

In the first essay I propose a novel pricing model for options on commodity futures motivated from the economic theory of optimal storage, and consistent with implications of plant physiology on the importance of weather stress. The model is based on a Generalized Lambda Distribution (GLD) that allows greater flexibility in higher moments of the expected terminal distribution of futures price. I find a statistically significant negative relationship between ending stocks-to-use and implied skewness, as predicted by the theory of storage. Intra-year dynamics of implied skewness reflect the fact that resolution of uncertainty in corn supply is resolved during the corn growth phase from corn silking through maturity. Impacts of storage and weather on the distribution of terminal futures prices jointly explain upward sloping implied volatility curves. In the second paper, a partially overlapping time series (POTS) model is estimated to examine price behavior in simultaneously traded Class III milk futures contracts. POTS is a latent factor model that measures price changes in futures as a linear combination of a common factor, i.e. information affecting all traded contracts, and an idiosyncratic term specific to each contract. The importance of a common factor in price volatility determination for dairy is related to capital production factors, i.e. the dairy herd. It is shown that Class III volatility decreases as contracts approach maturity. The importance of the common factor declines as one approaches maturity, implying that individual contract months are poor substitutes in hedging a specific month’s cash price risk. Thus, despite relatively low liquidity in the market, it is useful to have 12 contract delivery months per year. The third essay examines price discovery, volatility spillovers and the impacts of speculation in the dairy sector. I find that the flow of information in the mean prices is predominantly from futures to cash, while volatility spillovers are bidirectional. I propose an extension of the BEKK variance model that I refer to as GARCH-MEX. Utilizing the model to evaluate the impact of speculation I find strong evidence against the hypothesis that excessive speculation is increasing the conditional variance of futures prices.