Do Volatility Smiles Matter for Pricing Asian Basket Options? The Case of Livestock Gross Margin Insurance for Dairy CattleDec. 2014 - Dec. 2015 This project is a follow-up on a working paper of the same title my professor undertook back in 2012. The main research question is whether or not volatility smiles in commodity markets affect the premium of Livestock Gross Margin (LGM). The official LGM rating method assumes flat volatility curves for all futures contracts. Both the original working paper and this follow-up project show that the perceived volatility curves have negligible effect on LGM premiums in the official deductible range ($0.00 - $2.00). However, the curves make gradual and meaningful deviations from the official method as the deductibles wage higher and higher.
My job was to expand the existing analysis to cover more years of data and bigger range of deductibles. The original working paper only used data from 2009 when the headwind of the financial crisis hit the dairy industry at its worst. Given 2009's historical notoriety, the original paper simply studied a special case of the markets. I extended the study to include ten years of data ranging from 2005 to 2014. Because the project uses 10 years worth of CME high-frequency data that the computer code from the original paper simply was not able to handle, I revamped the existing computer program and made numerous additions.
Several highlights of this projects include:
Due to the complexity of the project, it is further explained in the following pages:
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