Pricing average price options for the 1990 Mexican and Venezuelan recapture clauses

This paper derived closed form solutions for the pricing of options on average prices and recapture clauses. On this basis, the values of recapture clauses in the Mexico and Venezuela agreements under alternative assumptions regarding the state variable underlying the clauses are estimated. The paper shows that the sensitivity of the values of the recapture clauses with respect to the stochastic process of the underlying variable is different than expected. The more"stationary"the process driving the underlying variable becomes, the more valuable the recapture clause becomes. The reason is that the effect of an increasing variance on the value of the recapture clauses is analytically unclear since in the two agreements the clauses are"collars", bounded above and below. Only in the empirical application does it show that increasing the variance reduces the value of the collar.