Pricing options on agricultural futures: An application of the constant elasticity of variance option pricing model

A study was undertaken to examine an appropriate pricing model for options on agricultural futures. Specifically examined are: 1. the stochastic behavior of agricultural futures prices and how these prices violate the underlying Black-Scholes (B-S) formula assumptions (1973), and 2. alternatives to...

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Bibliographic Details
Published in:The journal of futures markets 1985-07, Vol.5 (2), p.247-258
Main Authors: Choi, Jin W., Longstaff, Francis A.
Format: Article
Language:English
Subjects:
Agricultural commodities
Arbitrage
Commodity futures
Elasticity
Futures
Options
Partial differential equations
Prices
Pricing
Seasonal variations
Securities prices
Soybeans
Standard deviation
Time series
Variance analysis
Volatility
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Summary:A study was undertaken to examine an appropriate pricing model for options on agricultural futures. Specifically examined are: 1. the stochastic behavior of agricultural futures prices and how these prices violate the underlying Black-Scholes (B-S) formula assumptions (1973), and 2. alternatives to the B-S formula that are more consistent with the stochastic behavior of agricultural futures prices. The study's empirical results are based on data on soybean futures for contracts expiring in the period 1979-1983. Seasonal volatility in soybean futures quasi-returns was identified and shown to be inconsistent with the underlying assumptions of the B-S option pricing model, which is based on constant variance of the quasi-return. Cox's constant elasticity of variance (CEV) model (1975) was found to be a viable approach to pricing options on agricultural futures with seasonal volatility if the level of volatility was related to price level. All evidence suggests that the CEV model is theoretically superior to the B-S model for pricing option on soybean futures. Further evidence is needed for other agricultural commodities.
ISSN:0270-7314
1096-9934
DOI:10.1002/fut.3990050208