Comparative study of option pricing models for commodities

Abstract

This paper essentially deals with the study of the developing commodity markets in India. We have aimed to give the reader a useful insight through the development of the commodity markets and compare two commodities namely coffee and platinum. The reasons we chose coffee and platinum are (1) Coffee, a high value life-cycle product could well be compared with platinum, a high-value life-cycle independent product with respect to derivatives (2) Coffee and platinum markets are well developed world over The first section of the paper deals with an introduction to the derivative instruments. It is followed by a section on the history of the Indian commodity market where in the need for a commodity market in India is discussed along with the problems faced by the Indian market currently. The history and trading practices, such as price factors of both platinum and coffee are discussed thereafter. The derivatives market in coffee and platinum are discussed. In this section, the factors that make an efficient derivative market is elaborated and contrasted with the Indian market. This section also deals with the price support policy and the problems with the regulatory authority, FMC. The econometric analysis of the coffee and platinum data is explained in the next section which also explains the theory behind the analysis. The ADF test and cointegration testing mechanism are utilized for the data analysis and the findings are reported thereafter. The last section compiles all the findings and forms the conclusion. The coffee market is highly volatile due to its dependency on its life-cycle and the relaxation of the regulatory authority alone wouldn’t deliver an efficient market. On the other hand, platinum markets are less volatile and can be exactly modeled maybe. The regulatory body has to be first concerned about these issues rather than the high premiums charged on the option. Also, government support is essential for the initial deployment of the options market.