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Pricing of Swing Options in a Mean Reverting Model with Jumps

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  • Mats Kjaer
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    Abstract

    We investigate the pricing of swing options in a model where the logarithm of the spot price is the sum of a deterministic seasonal trend and an Ornstein-Uhlenbeck process driven by a jump diffusion. First we calibrate the model to Nord Pool electricity market data. Second, the existence of an optimal exercise strategy is proved, and we present a numerical algorithm for computation of the swing option prices. It involves dynamic programming and the solution of multiple parabolic partial integro-differential equations by finite differences. Numerical results show that adding jumps to a diffusion may result in 2-35% higher swing option prices, depending on the moneyness and timing flexibility of the option.

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    File URL: http://www.tandfonline.com/doi/abs/10.1080/13504860802170556
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    Bibliographic Info

    Article provided by Taylor & Francis Journals in its journal Applied Mathematical Finance.

    Volume (Year): 15 (2008)
    Issue (Month): 5-6 ()
    Pages: 479-502

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    Handle: RePEc:taf:apmtfi:v:15:y:2008:i:5-6:p:479-502

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    Web page: http://www.tandfonline.com/RAMF20

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    Web: http://www.tandfonline.com/pricing/journal/RAMF20

    Related research

    Keywords: Energy derivatives; swing options; jump diffusions; parabolic PIDEs; finite differences;

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    Cited by:
    1. Marcus Eriksson & Jukka Lempa & Trygve Kastberg Nilssen, 2013. "Swing options in commodity markets: A multidimensional L\'evy diffusion model," Papers 1302.6399, arXiv.org.
    2. 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.

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