Can real option values explain apparent storage at a loss?

Abstract

Since decisions to sell grain are irreversible, waiting to sell grain can have a real option value. This real option value may explain why producers appear to store too long. A new seasonal mean reversion model is estimated that allows prices to be a random walk with drift within a season, but mean reverting across crop years. Unless prices are extremely low, selling before mean reversion begins is optimal. Thus, the real option value of waiting does not explain why some producers seem to store at a loss in the latter part of crop years.

Keywords:

• real option value
• seasonal mean reversion
• storage
• grain

JEL Classification:

• C22
• D92
• G13
• Q13

Notes

¹ Fackler and Livingston (2002) include seasonal volatility. Our approach and the approach of Chen and Yang (1999) can handle seasonal volatility. We estimated our models with seasonal volatility, but seasonal volatility was small so we elected to go with the simpler model that did not include seasonal volatility.

² Future research may want to consider using the trinomial method of Ji and Brorsen (2011) since it has greater computational speed and can consider nonlognormal distributions.

³ Note that since the model does not fully mean revert within a year and that a 5-year moving average is used as the attractor, the underlying model is not stationary.