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Valuation of Commodity-Based Swing Options

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  • Patrick Jaillet

    ()
    (Department of Civil and Environmental Engineering, 77 Massachusetts Avenue, Building 1-290, Massachusetts Institute of Technology, Cambridge, Massachusetts 02139)

  • Ehud I. Ronn

    ()
    (Department of Finance, McCombs School of Business, University of Texas at Austin, 1 University Station, B6600, Austin, Texas 78712-1179)

  • Stathis Tompaidis

    ()
    (MSIS Department, McCombs School of Business, University of Texas at Austin, 1 University Station, B6500, Austin, Texas 78712-1175)

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    Abstract

    In the energy markets, in particular the electricity and natural gas markets, many contracts incorporate flexibility-of-delivery options known as "swing" or "take-or-pay" options. Subject to daily as well as periodic constraints, these contracts permit the option holder to repeatedly exercise the right to receive greater or smaller amounts of energy. We extract market information from forward prices and volatilities and build a pricing framework for swing options based on a one-factor mean-reverting stochastic process for energy prices that explicitly incorporates seasonal effects. We present a numerical scheme for the valuation of swing options calibrated for the case of natural gas.

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    File URL: http://dx.doi.org/10.1287/mnsc.1040.0240
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    Bibliographic Info

    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 50 (2004)
    Issue (Month): 7 (July)
    Pages: 909-921

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    Handle: RePEc:inm:ormnsc:v:50:y:2004:i:7:p:909-921

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    Related research

    Keywords: energy prices; seasonality; one-factor model; numerical valuations; dynamic programming; binomial forest;

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    Cited by:
    1. Nikolay Aleksandrov & Raphael Espinoza & Lajos Gyurko, 2012. "Optimal Oil Production and the World Supply of Oil," OxCarre Working Papers 092, Oxford Centre for the Analysis of Resource Rich Economies, University of Oxford.
    2. Álvaro Cartea & Carlos González-Pedraz, 2010. "How much should we pay for interconnecting electricity markets? A real options approach," Business Economics Working Papers wb103206, Universidad Carlos III, Departamento de Economía de la Empresa.
    3. Cartea, Álvaro & Williams, Thomas, 2008. "UK gas markets: The market price of risk and applications to multiple interruptible supply contracts," Energy Economics, Elsevier, vol. 30(3), pages 829-846, May.
    4. García de la Vega, Víctor Manuel & Ruiz Porras, Antonio, 2009. "Modelos Estocásticos para el Precio Spot y del Futuro de Commodities con Alta Volatilidad y Reversión a la Media," Revista de Administración, Finanzas y Economía (Journal of Management, Finance and Economics), Tecnológico de Monterrey, Campus Ciudad de México, vol. 3(2), pages 1-24.
    5. Marcus Eriksson & Jukka Lempa & Trygve Kastberg Nilssen, 2013. "Swing options in commodity markets: A multidimensional L\'evy diffusion model," Papers 1302.6399, arXiv.org.
    6. S\"oren Christensen & Albrecht Irle & Stephan J\"urgens, 2012. "Optimal multiple stopping with random waiting times," Papers 1205.1966, arXiv.org.
    7. N. Aleksandrov & B. Hambly, 2010. "A dual approach to multiple exercise option problems under constraints," Computational Statistics, Springer, vol. 71(3), pages 503-533, June.
    8. Christian Bender & Nikolai Dokuchaev, 2013. "A First-Order BSPDE for Swing Option Pricing," Papers 1305.3988, arXiv.org.
    9. Rodrigo S. Targino & Gareth W. Peters & Georgy Sofronov & Pavel V. Shevchenko, 2013. "Optimal insurance purchase strategies via optimal multiple stopping times," Papers 1312.0424, arXiv.org.
    10. Felix, Bastian Joachim & Weber, Christoph, 2012. "Gas storage valuation applying numerically constructed recombining trees," European Journal of Operational Research, Elsevier, vol. 216(1), pages 178-187.
    11. Kourouvakalis, Stylianos, 2008. "Méthodes numériques pour la valorisation d'options swings et autres problèmes sur les matières premières," Economics Thesis from University Paris Dauphine, Paris Dauphine University, number 123456789/116 edited by Geman, Hélyette, September.
    12. Marcus Eriksson & Jukka Lempa & Trygve Nilssen, 2014. "Swing options in commodity markets: a multidimensional Lévy diffusion model," Computational Statistics, Springer, vol. 79(1), pages 31-67, February.
    13. John Schoenmakers, 2012. "A pure martingale dual for multiple stopping," Finance and Stochastics, Springer, vol. 16(2), pages 319-334, April.

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