Pricing derivatives in agricultural land markets

Purpose - The purpose of this paper is to discuss the potential of land derivatives in light of an increased engagement of non-agricultural investors. These financial instruments allow participation in the market without physically acquiring land and further contribute to increased market liquidity. One prerequisite for their establishment is the availability of a transparent pricing framework. This paper aims to identify such a framework for derivatives on a farmland index. Design/methodology/approach - The study reviews the current state of farmland derivatives and discusses different alternatives in constructing appropriate farmland indices. It provides an overview on pricing methods for real estate derivatives and applies a risk-neutral valuation approach to the NCREIF Farmland Index. Findings - Derivative prices are sensitive to the market price of risk. The pricing of traded products is hampered by missing information to determine the market price of risk. This limits the practical implementation of land derivatives in the near future. Originality/value - Despite few opportunities for trading land-based derivatives based on funds, this line of research has so far been limited by the lack of an adequate pricing approach. This paper adds to the sparse empirical literature on derivatives in land markets by identifying and applying a pricing framework.