How Much Would You Pay to Resolve Volatility Risk in Agricultural Commodity Markets?

37 Pages Posted: 25 Apr 2019

See all articles by Lei Yan

Lei Yan

University of Illinois at Urbana-Champaign

Philip Garcia

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics

Date Written: August 19, 2018

Abstract

This article investigates the pricing of volatility risk in agricultural commodity markets. We show theoretically that the cost of bearing volatility risk can be measured using returns to delta-neutral straddles. Using a sample of options for five commodities (corn, soybeans, Chicago wheat, live cattle, and lean hogs) for 2002–2016, we provide the following findings. First, returns to delta-neutral straddles are negative, ranging between –0.87% and –0.06% per day, suggesting that investors are willing to pay a cost to avoid volatility risk. Second, volatility risk is priced mainly at short maturities (within 2 months) but is negligible at longer maturities, and this term structure of volatility risk prevails in all markets. Last, volatility risk is more pronounced on the day immediately preceding the U.S. Department of Agriculture (USDA) announcements but is not effectively explained by economic or commodity specific factors.

Keywords: volatility risk, commodity options, straddle, term structure

JEL Classification: G12, G13, G14, Q13

Suggested Citation

Yan, Lei and Garcia, Philip, How Much Would You Pay to Resolve Volatility Risk in Agricultural Commodity Markets? (August 19, 2018). Available at SSRN: https://ssrn.com/abstract=3360791 or http://dx.doi.org/10.2139/ssrn.3360791

Lei Yan (Contact Author)

University of Illinois at Urbana-Champaign

601 E John St
Champaign, IL 61820
United States

Philip Garcia

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics ( email )

1301 W. Gregory Drive
427 Mumford Hall
Urbana, IL 61801
United States
217-333-0644 (Phone)
217-333-5538 (Fax)

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