Option Pricing on Renewable Commodity Markets
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Options markets on agricultural commodities with maturities that exceed 13 months
seldom trade. Our hypothesis is that this market failure is due to the absence of an
accurate option pricing model for commodities where mean reversion can be expected.
Standard option pricing models assume proportionality between price variance and time
to maturity. This proportionality is not a valid assumption for commodities where supply
response works to bring prices back to production costs. The model suggests that
traditional option pricing models will overprice long-term options on these markets.