Title: Estimating cost of volatility risk in selected agricultural commodity markets
Authors: Lei Yan - University of Illinois at Urbana-Champaign (United States) [presenting]
Abstract: The cost of volatility risk in agricultural commodity markets is investigated by examining delta-neutral straddle gains. Within a stochastic volatility model, delta-neutral straddle gains scaled by futures price are mainly determined by the price of volatility risk and its risk exposure. Using a sample of options for 2003-2016, we show that volatility risk is priced with a negative premium in the grain and livestock markets. The cost of bearing volatility risk exhibits a non-trivial term structure, with its absolute value declining sharply in maturity and approaching zero beyond three months. Regression analyses reveal that the cost of volatility risk is related to expected volatility, time to maturity, and futures trading volume, and becomes more evident on the day preceding the release of USDA reports. The results highlight the importance of volatility risk and carry important implications for option pricing and volatility forecasting in commodity markets.