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Representation of infinite dimensional forward price models in commodity markets

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  • Fred Espen Benth
  • Paul Kruhner

Abstract

We study the forward price dynamics in commodity markets realized as a process with values in a Hilbert space of absolutely continuous functions defined by Filipovi\'c. The forward dynamics are defined as the mild solution of a certain stochastic partial differential equation driven by an infinite dimensional L\'evy process. It is shown that the associated spot price dynamics can be expressed as a sum of Ornstein-Uhlenbeck processes, or more generally, as a sum of certain stationary processes. These results link the possibly infinite dimensional forward dynamics to classical commodity spot models. We continue with a detailed analysis of multiplication and integral operators on the Hilbert spaces and show that Hilbert-Schmidt operators are essentially integral operators. The covariance operator of the L\'evy process driving the forward dynamics and the diffusion term can both be specified in terms of such operators, and we analyse in several examples the consequences on model dynamics and their probabilistic properties. Also, we represent the forward price for contracts delivering over a period in terms of an integral operator, a case being relevant for power and gas markets. In several examples we reduce our general model to existing commodity spot and forward dynamics.

Suggested Citation

  • Fred Espen Benth & Paul Kruhner, 2014. "Representation of infinite dimensional forward price models in commodity markets," Papers 1403.4111, arXiv.org.
    • Handle: RePEc:arx:papers:1403.4111
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    References listed on IDEAS

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    11. 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.
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