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Hedging strategies for energy derivatives

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  • P. Leoni
  • N. Vandaele
  • M. Vanmaele

Abstract

In this article, we define a hedging strategy in a setting typical for the commodity market. Firstly, we prove the existence of the locally risk-minimizing (LRM) hedging strategy for payment streams in this setting. Next, a three-step procedure is described to determine the LRM hedging strategy. Then the procedure is illustrated for stochastic volatility models, as these models are a special case of the non-traded situation which frequently occurs in the commodity markets. Finally, we introduce the (adjusted) LRM hedging strategy in the non-traded setting and for this specific setting we numerically show the outperformance of this strategy compared with current market practices.

Suggested Citation

  • P. Leoni & N. Vandaele & M. Vanmaele, 2014. "Hedging strategies for energy derivatives," Quantitative Finance, Taylor & Francis Journals, vol. 14(10), pages 1725-1737, October.
    • Handle: RePEc:taf:quantf:v:14:y:2014:i:10:p:1725-1737
    DOI: 10.1080/14697688.2013.836294
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    Cited by:

    1. Takuji Arai & Yuto Imai & Ryoichi Suzuki, 2016. "Numerical Analysis On Local Risk-Minimization For Exponential Lévy Models," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 19(02), pages 1-27, March.
    2. David B. Colwell & Nadima El‐Hassan & Oh Kang Kwon, 2021. "Variance minimizing strategies for stochastic processes with applications to tracking stock indices," International Review of Finance, International Review of Finance Ltd., vol. 21(2), pages 430-446, June.
    3. Ceci, Claudia & Colaneri, Katia & Cretarola, Alessandra, 2017. "Unit-linked life insurance policies: Optimal hedging in partially observable market models," Insurance: Mathematics and Economics, Elsevier, vol. 76(C), pages 149-163.
    4. Vedenov, Dmitry & Power, Gabriel J., 2022. "We don't need no fancy hedges! Or do we?," International Review of Financial Analysis, Elsevier, vol. 81(C).
    5. Monika Harčariková, 2018. "Managing Price Risk in the Corn Market Using Option Strategies," Acta Universitatis Agriculturae et Silviculturae Mendelianae Brunensis, Mendel University Press, vol. 66(3), pages 767-779.
    6. Hasan Dinçer & Serhat Yüksel & Fatih Pınarbaşı & Mehmet Ali Alhan, 2020. "Risky Financial Assets in Financial Integration and the Impacts of Derivatives on Banking Returns," World Scientific Book Chapters, in: Stéphane Goutte & Khaled Guesmi (ed.), Risk Factors and Contagion in Commodity Markets and Stocks Markets, chapter 6, pages 133-159, World Scientific Publishing Co. Pte. Ltd..
    7. Takuji Arai & Yuto Imai & Ryoichi Suzuki, 2015. "Numerical analysis on local risk-minimization forexponential L\'evy models," Papers 1506.03898, arXiv.org.

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