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Risk valuation of quanto derivatives on temperature and electricity

Author

Listed:
  • Aurélien Alfonsi

    (MATHRISK - Mathematical Risk Handling - UPEM - Université Paris-Est Marne-la-Vallée - ENPC - École des Ponts ParisTech - Inria de Paris - Inria - Institut National de Recherche en Informatique et en Automatique, CERMICS - Centre d'Enseignement et de Recherche en Mathématiques et Calcul Scientifique - ENPC - École des Ponts ParisTech)

  • Nerea Vadillo

    (CERMICS - Centre d'Enseignement et de Recherche en Mathématiques et Calcul Scientifique - ENPC - École des Ponts ParisTech)

Abstract

This paper develops a coupled model for day-ahead electricity prices and average daily temperature which allows to model quanto weather and energy derivatives. These products have gained on popularity as they enable to hedge against both volumetric and price risks. Electricity day-ahead prices and average daily temperatures are modelled through non homogeneous Ornstein-Uhlenbeck processes driven by a Brownian motion and a Normal Inverse Gaussian Lévy process, which allows to include dependence between them. A Conditional Least Square method is developed to estimate the different parameters of the model and used on real data. Then, explicit and semi-explicit formulas are obtained for derivatives including quanto options and compared with Monte Carlo simulations. Last, we develop explicit formulas to hedge statically single and double sided quanto options by a portfolio of electricity options and temperature options (CDD or HDD).

Suggested Citation

  • Aurélien Alfonsi & Nerea Vadillo, 2023. "Risk valuation of quanto derivatives on temperature and electricity," Working Papers hal-04358505, HAL.
    • Handle: RePEc:hal:wpaper:hal-04358505
    DOI: 10.48550/arXiv.2310.07692
    Note: View the original document on HAL open archive server: https://hal.science/hal-04358505
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