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Swing options in commodity markets: A multidimensional L\'evy diffusion model

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  • Marcus Eriksson
  • Jukka Lempa
  • Trygve Kastberg Nilssen
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    Abstract

    We study valuation of swing options on commodity markets when the commodity prices are driven by multiple factors. The factors are modeled as diffusion processes driven by a multidimensional L\'evy process. We set up a valuation model in terms of a dynamic programming problem where the option can be exercised continuously in time. Here, the number of swing rights is given by a total volume constraint. We analyze some general properties of the model and study the solution by analyzing the associated HJB-equation. Furthermore, we discuss the issues caused by the multi-dimensionality of the commodity price model. The results are illustrated numerically with three explicit examples.

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    File URL: http://arxiv.org/pdf/1302.6399
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    Paper provided by arXiv.org in its series Papers with number 1302.6399.

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    Date of creation: Feb 2013
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    Handle: RePEc:arx:papers:1302.6399

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    1. Edoli, Enrico & Fiorenzani, Stefano & Ravelli, Samuele & Vargiolu, Tiziano, 2013. "Modeling and valuing make-up clauses in gas swing contracts," Energy Economics, Elsevier, vol. 35(C), pages 58-73.
    2. Patrick Jaillet & Ehud I. Ronn & Stathis Tompaidis, 2004. "Valuation of Commodity-Based Swing Options," Management Science, INFORMS, INFORMS, vol. 50(7), pages 909-921, July.
    3. Ben Hambly & Sam Howison & Tino Kluge, 2009. "Modelling spikes and pricing swing options in electricity markets," Quantitative Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 9(8), pages 937-949.
    4. René Carmona & Nizar Touzi, 2008. "Optimal Multiple Stopping And Valuation Of Swing Options," Mathematical Finance, Wiley Blackwell, Wiley Blackwell, vol. 18(2), pages 239-268.
    5. Mats Kjaer, 2008. "Pricing of Swing Options in a Mean Reverting Model with Jumps," Applied Mathematical Finance, Taylor & Francis Journals, Taylor & Francis Journals, vol. 15(5-6), pages 479-502.
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