Ex-ante valuation of United States agricultural support programs: An application of option pricing theory and methods
Tirupattur, Viswanath
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https://hdl.handle.net/2142/19275
Description
Title
Ex-ante valuation of United States agricultural support programs: An application of option pricing theory and methods
Author(s)
Tirupattur, Viswanath
Issue Date
1995
Doctoral Committee Chair(s)
Hauser, Robert J.
Department of Study
Agricultural and Consumer Economics
Discipline
Agricultural Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Agricultural
Economics, Finance
Language
eng
Abstract
"Given the size and variability of U.S. federal outlays on agricultural support programs, alternative means of structuring and implementing the programs are frequently considered, particularly through private sector risk management institutions such as futures and option markets. The Option Pilot Project (OPP) is one such alternative. Even though the similarity between government support programs and options has been addressed conceptually by many researchers, quantitative estimates of contingent values of agricultural programs have often been based on the direct application of existing option valuation models. There are several ""exotic"" option-like features embedded in the U.S. agricultural support programs, and thus the existing option pricing models have to be substantially modified to provide ex-ante valuation estimates of the programs."
The purpose of the present analysis is to develop and apply theoretical models for valuing U.S. farm programs in an option pricing framework, focussing on the exotic option features. These features involve path-dependent payoffs of various kinds, upper and lower bounds on the payoff region, two state variables, advance payments, ceilings on total payoffs, and a combination of American and European exercise characteristics. Ex-ante valuation estimates of the existing government programs are compared to those of the OPP puts to in a risk-neutral framework.
"Theoretical models are derived for pricing derivative market instruments with payoff structures identical to those implied by the different components of the U.S. agricultural support programs. The resulting models are used to obtain ""market premiums"" for the exotic contingent claims embedded in these programs. These models do not have analytical solutions and but can be estimated with numerical approximation procedures."
The study provides numerical estimates of the value of the traditional government programs under alternative parametric assumptions about prices, yields and price and yield volatilities. The results indicate that it is important to explicitly recognize the exotic features of the contingent claims implicit in the agricultural support programs, and that the OPP has a slightly higher expected cost to the government than current farm programs.
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