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A note on arbitrage-free pricing of forward contracts in energy markets

Author

Listed:
  • Fred Espen Benth
  • Lars Ekeland
  • Ragnar Hauge
  • BjøRn Fredrik Nielsen

Abstract

Arbitrage theory is used to price forward (futures) contracts in energy markets, where the underlying assets are non-tradeable. The method is based on the so-called 'fitting of the yield curve' technique from interest rate theory. The spot price dynamics of Schwartz is generalized to multidimensional correlated stochastic processes with Wiener and Levy noise. Findings are illustrated with examples from oil and electricity markets.

Suggested Citation

  • Fred Espen Benth & Lars Ekeland & Ragnar Hauge & BjøRn Fredrik Nielsen, 2003. "A note on arbitrage-free pricing of forward contracts in energy markets," Applied Mathematical Finance, Taylor & Francis Journals, vol. 10(4), pages 325-336.
  • Handle: RePEc:taf:apmtfi:v:10:y:2003:i:4:p:325-336
    DOI: 10.1080/1350486032000160777
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    Citations

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    Cited by:

    1. John Crosby, 2008. "A multi-factor jump-diffusion model for commodities," Quantitative Finance, Taylor & Francis Journals, vol. 8(2), pages 181-200.
    2. Benth, Fred Espen & Koekebakker, Steen, 2008. "Stochastic modeling of financial electricity contracts," Energy Economics, Elsevier, vol. 30(3), pages 1116-1157, May.
    3. Cartea, Álvaro & Williams, Thomas, 2008. "UK gas markets: The market price of risk and applications to multiple interruptible supply contracts," Energy Economics, Elsevier, vol. 30(3), pages 829-846, May.
    4. Niall Farrell, Mel T. Devine, William T. Lee, James P. Gleeson, and Sean Lyons, 2017. "Specifying An Efficient Renewable Energy Feed-in Tariff," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).
    5. Asger Lunde & Anne Floor Brix & Wei Wei, 2013. "A Generalized Schwartz Model for Energy Spot Prices - Estimation using a Particle MCMC Method," CREATES Research Papers 2015-46, Department of Economics and Business Economics, Aarhus University.
    6. Ren'e Aid & Luciano Campi & Delphine Lautier, 2015. "On the spot-futures no-arbitrage relations in commodity markets," Papers 1501.00273, arXiv.org, revised Feb 2018.
    7. Joanna Janczura, 2014. "Pricing electricity derivatives within a Markov regime-switching model: a risk premium approach," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 79(1), pages 1-30, February.
    8. Green, Rikard, 2015. "A Power Market Forward Curve with Hydrology Dependence An Approach based on Artificial Neural Networks," Knut Wicksell Working Paper Series 2015/1, Lund University, Knut Wicksell Centre for Financial Studies.
    9. Kurucak, Abdurrahman & Shcherbakova, Anastasia, 2016. "Estimating the hedging value of an energy exchange in Turkey to a retail power consumer," Energy, Elsevier, vol. 101(C), pages 16-26.
    10. René Aid & Luciano Campi & Nicolas Langrené, 2010. "A structural risk-neutral model for pricing and hedging power derivatives," Working Papers hal-00525800, HAL.
    11. Tsitakis, D. & Xanthopoulos, S. & Yannacopoulos, A.N., 2006. "A closed-form solution for the price of cross-commodity electricity derivatives," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 371(2), pages 543-551.
    12. Alvaro Cartea & Marcelo Figueroa, 2005. "Pricing in Electricity Markets: A Mean Reverting Jump Diffusion Model with Seasonality," Applied Mathematical Finance, Taylor & Francis Journals, vol. 12(4), pages 313-335.
    13. Erlwein, Christina & Benth, Fred Espen & Mamon, Rogemar, 2010. "HMM filtering and parameter estimation of an electricity spot price model," Energy Economics, Elsevier, vol. 32(5), pages 1034-1043, September.
    14. repec:spr:eurase:v:7:y:2017:i:2:d:10.1007_s40822-017-0066-0 is not listed on IDEAS
    15. Ballester, Cristina & Furió, Dolores, 2015. "Effects of renewables on the stylized facts of electricity prices," Renewable and Sustainable Energy Reviews, Elsevier, vol. 52(C), pages 1596-1609.
    16. repec:spr:compst:v:79:y:2014:i:1:p:1-30 is not listed on IDEAS
    17. Benth Fred E & Saltyte-Benth Jurate, 2006. "Analytical Approximation for the Price Dynamics of Spark Spread Options," Studies in Nonlinear Dynamics & Econometrics, De Gruyter, vol. 10(3), pages 1-28, September.
    18. Xavier Warin, 2017. "Variance optimal hedging with application to Electricity markets," Papers 1711.03733, arXiv.org.
    19. Joanna Janczura, 2012. "Pricing electricity derivatives within a Markov regime-switching model," Papers 1203.5442, arXiv.org.

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