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Swing options in commodity markets: A multidimensional L\'evy diffusion model

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  • Marcus Eriksson
  • Jukka Lempa
  • Trygve Kastberg Nilssen

Abstract

We study valuation of swing options on commodity markets when the commodity prices are driven by multiple factors. The factors are modeled as diffusion processes driven by a multidimensional L\'evy process. We set up a valuation model in terms of a dynamic programming problem where the option can be exercised continuously in time. Here, the number of swing rights is given by a total volume constraint. We analyze some general properties of the model and study the solution by analyzing the associated HJB-equation. Furthermore, we discuss the issues caused by the multi-dimensionality of the commodity price model. The results are illustrated numerically with three explicit examples.

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  • Marcus Eriksson & Jukka Lempa & Trygve Kastberg Nilssen, 2013. "Swing options in commodity markets: A multidimensional L\'evy diffusion model," Papers 1302.6399, arXiv.org.
    • Handle: RePEc:arx:papers:1302.6399
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    References listed on IDEAS

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    1. M. Dahlgren, 2005. "A Continuous Time Model to Price Commodity-Based Swing Options," Review of Derivatives Research, Springer, vol. 8(1), pages 27-47, June.
    2. Ben Hambly & Sam Howison & Tino Kluge, 2009. "Modelling spikes and pricing swing options in electricity markets," Quantitative Finance, Taylor & Francis Journals, vol. 9(8), pages 937-949.
    3. Mats Kjaer, 2008. "Pricing of Swing Options in a Mean Reverting Model with Jumps," Applied Mathematical Finance, Taylor & Francis Journals, vol. 15(5-6), pages 479-502.
    4. Edoli, Enrico & Fiorenzani, Stefano & Ravelli, Samuele & Vargiolu, Tiziano, 2013. "Modeling and valuing make-up clauses in gas swing contracts," Energy Economics, Elsevier, vol. 35(C), pages 58-73.
    5. René Carmona & Nizar Touzi, 2008. "Optimal Multiple Stopping And Valuation Of Swing Options," Mathematical Finance, Wiley Blackwell, vol. 18(2), pages 239-268.
    6. Patrick Jaillet & Ehud I. Ronn & Stathis Tompaidis, 2004. "Valuation of Commodity-Based Swing Options," Management Science, INFORMS, vol. 50(7), pages 909-921, July.
    7. Fred Espen Benth & Jan Kallsen & Thilo Meyer-Brandis, 2007. "A Non-Gaussian Ornstein-Uhlenbeck Process for Electricity Spot Price Modeling and Derivatives Pricing," Applied Mathematical Finance, Taylor & Francis Journals, vol. 14(2), pages 153-169.
    8. M. I. M. Wahab & Z. Yin & N. C. P. Edirisinghe, 2010. "Pricing swing options in the electricity markets under regime-switching uncertainty," Quantitative Finance, Taylor & Francis Journals, vol. 10(9), pages 975-994.
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    Cited by:

    1. M. Basei & A. Cesaroni & T. Vargiolu, 2013. "Optimal exercise of swing contracts in energy markets: an integral constrained stochastic optimal control problem," Papers 1307.1320, arXiv.org.

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