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Pricing energy futures options: The role of seasonality and liquidity

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  • Chen, Wenting
  • Yang, Zhao
  • He, Xin-Jiang

Abstract

In this paper, we propose an enhanced pricing framework for energy derivatives by incorporating seasonal effects and liquidity risks into the traditional two-factor model. The main theoretical challenge lies in deriving a tractable semi-analytical solution for the price of energy futures options under this enhanced model specification, which we have successfully achieved through advanced analytical techniques. Our solution demonstrates superior computational efficiency compared to the Monte-Carlo method, and greatly facilitates the model calibration process. Empirical results reveal that the proposed model outperforms both the standard two-factor model and the model with a seasonal-only specification, validating the importance of jointly modeling seasonal factors and liquidity risks for pricing energy futures options.

Suggested Citation

  • Chen, Wenting & Yang, Zhao & He, Xin-Jiang, 2025. "Pricing energy futures options: The role of seasonality and liquidity," Energy Economics, Elsevier, vol. 149(C).
    • Handle: RePEc:eee:eneeco:v:149:y:2025:i:c:s014098832500564x
    DOI: 10.1016/j.eneco.2025.108737
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    Keywords

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    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • G17 - Financial Economics - - General Financial Markets - - - Financial Forecasting and Simulation
    • Q47 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - Energy Forecasting
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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