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Co-movements, option pricing and risk management: an application to WTI versus Brent spread options

Author

Listed:
  • Domenico De Giovanni

    (University of Calabria)

  • Arturo Leccadito

    (University of Calabria
    LFIN/LIDAM)

  • Debora Loccisano

    (Carleton University)

Abstract

Co-moments of asset returns play a major role in financial contagion during crises. We study the properties of a particular specification of the generalized bivariate normal distribution which allows for co-volatility and co-skewness. With this probability distribution, formulae for single-name and exchange options can be evaluated quickly since they are based on one-dimensional integrals. We provide a very precise approximation formula for spread option prices and derive the corresponding greeks. We perform a day-to-day re-estimation of the probability distribution on a dataset of WTI vs Brent spread options, showing the ability of this specification to capture the salient empirical features observed in the market. Finally, we show the impact of co-movements on portfolio risk management.

Suggested Citation

  • Domenico De Giovanni & Arturo Leccadito & Debora Loccisano, 2024. "Co-movements, option pricing and risk management: an application to WTI versus Brent spread options," Annals of Operations Research, Springer, vol. 336(1), pages 1039-1061, May.
  • Handle: RePEc:spr:annopr:v:336:y:2024:i:1:d:10.1007_s10479-022-05059-7
    DOI: 10.1007/s10479-022-05059-7
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    References listed on IDEAS

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