Valuing Target Price Support Programs with Average Option Pricing

Abstract

Abstract The U.S. government deficiency payment program supplements farm income by transferring income from taxpayers to farmers. When revenue lost due to the acreage restriction exceeds revenue gained from participating in the program, farmers lose money by participating. Therefore, measuring expected revenue from the government program is important so that farmers can decide whether to participate in the program. This study uses a GARCH average‐option pricing model and the Black average‐option pricing model to predict the implicit premium of the U.S. government deficiency payment program. The average‐option pricing model considers the average price of the underlying asset over a fixed period. A regression model based on the simulation results is provided so that the average‐option models can be easily used to project deficiency payments. The results can be used by extension economists to help producers decide whether to participate in the program.

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