Volatility and Price Jumps in Agricultural Futures Prices—Evidence from Wheat Options

Abstract

Evidence suggests that agricultural futures price movements have fat‐tailed distributions and exhibit sudden and unexpected price jumps. There is also evidence that the volatility of futures prices is time‐dependent both as a function of calendar‐time (seasonal effect) and time to maturity (maturity effect). This article extends Bates' (1991) jump‐diffusion option pricing model by including both seasonal and maturity effects in the volatility specification. Both in‐sample and out‐of‐sample procedures to fit market option prices on wheat futures show that the suggested model outperforms previous published models. A numerical example shows the magnitude of pricing errors for option valuation.