Evaluating Pricing Models for Options on Futures

Robert J. Hauser and Yue Liu

Review of Agricultural Economics, 1992, vol. 14, issue 1, 23-32

Abstract: Riskless hedging simulations are used to evaluate the performance of alternative models for pricing options on cattle futures and to identify efficiency characteristics of the options market. Seven option contracts are examined. Mispriced contracts and resulting portfolios were evaluated daily using Black's model under five different assumptions about how the price-variance forecast is derived. The results suggest that economic profits are possible if "good" short-term forecasts of variance are available. However, the ex-ante estimates of variance used did not consistently identify arbitrage opportunities. Thus, in general, inefficiency within the live-cattle options market was not indicated. Finally, the findings suggest that researchers and practitioners should focus more on short-term variances or variance rates than on variances of prices over the option's life.

Date: 1992
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