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Pricing of Energy Contracts: From Replication Pricing to Swing Options

In: Handbook of Risk Management in Energy Production and Trading

Author

Listed:
  • Raimund M. Kovacevic

    (University of Vienna)

  • Georg Ch. Pflug

    (ISOR and IIASA)

Abstract

The principle of replication or superhedging is widely used for valuating financial contracts, in particular, derivatives. In the special situation of energy markets, this principle is not quite appropriate and might lead to unrealistic high prices, when complete hedging is not possible, or to unrealistic low prices, when own production is involved. Therefore we compare it to further valuation strategies: acceptability pricing weakens the requirement of almost sure replication and indifference pricing accounts for the opportunity costs of producing for a considered contract. Finally, we describe a game-theoretic approach for valuating flexible contracts (swing options), which is based on bi-level optimization.

Suggested Citation

  • Raimund M. Kovacevic & Georg Ch. Pflug, 2013. "Pricing of Energy Contracts: From Replication Pricing to Swing Options," International Series in Operations Research & Management Science, in: Raimund M. Kovacevic & Georg Ch. Pflug & Maria Teresa Vespucci (ed.), Handbook of Risk Management in Energy Production and Trading, edition 127, chapter 0, pages 387-411, Springer.
    • Handle: RePEc:spr:isochp:978-1-4614-9035-7_15
    DOI: 10.1007/978-1-4614-9035-7_15
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