The impact of extreme weather events on implied volatility functions of agricultural options

Sammanfattning: The main aim of this thesis is to investigate the impact of extreme weather events on implied volatility functions of agricultural commodity options at different levels of moneyness. The thesis used daily data of the implied volatilties of four major US agricultural commodities at three moneyness levels for the period starting 2017 to 2022. Two types of extreme weather events are studied for the US in the selected time period. The conceptual framework of the study focusses on the different extreme weather and climate events,options with particular focus on implied volatilities derived through the Black and Scholes Model (BSM) and all these concepts are connected through the Efficient Market Hyphothesis theory. The thesis uses a GARCH (1,1) event study methodology with dummy variables to represent three periods around the selected events. The regressions are conducted at options that are at three levels of moneyness, namely in the money (ITM), at the money (ATM) and out of the money (otm). Analysis of the implied volatility of agricultural options show that these implied violatilties are not at constant levels of volatility as the initial BSM suggests. These options exhibit a smirk and smile pattern whereby options that are ITM and options that are OTM have higher implied volatilities compared to options ATM. The regression results show that the agricultural options market reacts to both Flooding and cyclone events. Howevr not all options were found to be significantly affected and there are some varying results on the different commodities, maturities and moneyness levels. Our results show that the regression coefficients for the dummy variables representing the periods aound the events decrease with longer time to maturity of the option.  Looking at the moneyness level we find that the ATM options were affected most significantly in our regressions. However, the Soybean options were one exception with significant results for ITM and OTM options. Lastly, the results tend to show a flattening of the IVFs as a result of an event, especially for flooding events.