Was there a peso problem in cattle options? Evidence from the 2003 bovine spongiform encephalopathy announcement

Abstract

Purpose

Pricing densities implied from options on live cattle futures show a persistent and negative skew. The purpose is to examine whether the skew can be explained, in part, by peso-type problems.

Design/methodology/approach

Two announcements of bovine spongiform encephalopathy (BSE) provide a natural setting within which to examine the validity of the peso-problem explanation. These announcements represent the first documented cases of BSE in North America. Prior to the announcements, the potential for BSE would have been known by market participants as the disease had been found among cattle in the British Isles, Europe and Asia. The paper uses options market data to compute implied moments of the pricing distribution for live cattle futures. The paper then analyzes these moments around BSE announcements.

Findings

The first Canadian BSE announcement impacted the mean and volatility but not the implied skew. Later in the year, BSE was found in a US cow and the paper finds a statistically significant change in the implied skew. The distribution showed a pronounced leftward skew prior to the US announcement but was nearly symmetric during the days afterwards. This finding is consistent with the market having priced the possibility of a BSE discovery into deep out-of-the-money put options.

Originality/value

Peso problems have been documented in other financial markets. The results are important because they suggest that they may also be important to agricultural markets and that agricultural options markets do account for low probability but highly important events.

Citation

Thomsen, M., M. McKenzie, A. and J. Power, G. (2013), "Was there a peso problem in cattle options? Evidence from the 2003 bovine spongiform encephalopathy announcement", Agricultural Finance Review, Vol. 73 No. 3, pp. 526-538. https://doi.org/10.1108/AFR-09-2012-0048