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https://hdl.handle.net/2142/82995
Description
Title
Are Agricultural Options Too Expensive
Author(s)
Urcola, Hernan
Issue Date
2007
Doctoral Committee Chair(s)
Irwin, Scott H.
Department of Study
Agricultural and Consumer Economics
Discipline
Agricultural and Consumer Economics
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Agricultural
Language
eng
Abstract
Corn, soybean, wheat and hog options trading volume has grown steadily. At the same time there is a persistent complaint about the high price of options. These complaints argue that, options trinkets are inefficient. If these claims are true, farmers would be buying expensive insurance, investors would be misallocating resources and researchers would need to review asset pricing theories. This analysis uses a dataset of 21 years of historical prices to test the sufficient condition for corn, soybean, wheat and hog options market efficiency. This test is implemented by analyzing whether expected returns from simulated trailing strategies equal zero. Returns are computed for 30- and 90-day holding periods and are classified into moneyness categories. Since option returns are function of the underlying futures price, theoretical benchmark returns accounting for the path of the underlying futures are also estimated. Theoretical benchmarks take out effects of the movements in the underlying futures, thus making returns comparable across time and markets. If option markets are efficient, theoretical and observed returns should not be statistically different. Results show that 73 of the 80 options return distributions include zero as expected return in the 95% confidence interval. For corn, soybean and wheat, when the difference between theoretical and observed return is statistically significant, pricing errors are of similar size to typical transaction costs. The average mispricing of in-the-money corn calls represents 0.51¢/bu, but typical transaction costs for these options are 1.16¢/bu. Soybean options exhibit the smallest pricing errors of all four commodities, and wheat options present mispricings of about 1.00¢/bu. Hog calls exhibit small prizing errors, but hog puts exhibit pricing errors larger than typical transaction costs. Therefore, arbitrage opportunities might have existed for these options. Results suggest that corn, soybean and wheat options and hog calls are efficiently priced. Hog puts are priced less efficiently. Results or this dissertation suggest that the mis-pricing claims are caused by biases in the agents' perception, of futures price distributions.
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