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Analytically pricing crude oil options under a jump-diffusion model with stochastic liquidity risk and convenience yield

Author

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  • Lin, Sha
  • Chen, Meiling
  • He, Xin-Jiang

Abstract

This study investigates the pricing issue of European crude oil options in a market with imperfect liquidity. We adopt a jump-diffusion model incorporating stochastic convenience yield to simulate crude oil price evolution, adjusted for the impacts of stochastic liquidity risk. A risk-neutral measure is established based on the Feynman-Kac theorem, followed by the presentation of a closed-form formula for determining the fair delivery price of the crude oil futures contract. This further give rise to an analytical price of the crude oil options. Novel formula’s correctness is verified by numerical tests that compare the analytical answer with Monte Carlo simulation. In conclusion, an empirical analysis is carried out to validate the proposed model using the crude oil options data available on the Shanghai International Energy Exchange (INE). The findings are contrasted to a benchmark model with constant liquidity, demonstrating the relevance of introducing stochastic liquidity into crude oil option pricing.

Suggested Citation

  • Lin, Sha & Chen, Meiling & He, Xin-Jiang, 2025. "Analytically pricing crude oil options under a jump-diffusion model with stochastic liquidity risk and convenience yield," The North American Journal of Economics and Finance, Elsevier, vol. 78(C).
    • Handle: RePEc:eee:ecofin:v:78:y:2025:i:c:s1062940825000646
    DOI: 10.1016/j.najef.2025.102424
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