Pricing Commodity Options when the Underlying Futures Price Exhibits Time-Varying Volatility

Robert J. Myers and Steven D. Hanson

American Journal of Agricultural Economics, 1993, vol. 75, issue 1, 121-130

Abstract: Standard commodity option pricing models assume proportional changes in the underlying futures price are i.i.d. normal. Empirical evidence suggests commodity futures price movements exhibit excess kurtosis and time-varying volatility. This paper presents option pricing models when time-varying volatility and excess kurtosis in the underlying futures price can be modeled as a GARCH process. Empirical results suggest that the GARCH option pricing model outperforms the standard Black option-pricing model, which uses historical volatilities. A closed-form approximation model using a variance forecast generated from the estimated GARCH process also outperforms Black's model and in many cases the general GARCH model as well.

Date: 1993
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Persistent link: https://EconPapers.repec.org/RePEc:oup:ajagec:v:75:y:1993:i:1:p:121-130.

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