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Capturing the power options smile by an additive two-factor model for overlapping futures prices

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  • Marco Piccirilli
  • Maren Diane Schmeck
  • Tiziano Vargiolu

Abstract

In this paper we introduce an additive two-factor model for electricity futures prices based on Normal Inverse Gaussian L\'evy processes, that fulfills a no-overlapping-arbitrage (NOA) condition. We compute European option prices by Fourier transform methods, introduce a specific calibration procedure that takes into account no-arbitrage constraints and fit the model to power option settlement prices of the European Energy Exchange (EEX). We show that our model is able to reproduce the different levels and shapes of the implied volatility (IV) profiles displayed by options with a variety of delivery periods.

Suggested Citation

  • Marco Piccirilli & Maren Diane Schmeck & Tiziano Vargiolu, 2019. "Capturing the power options smile by an additive two-factor model for overlapping futures prices," Papers 1910.01044, arXiv.org.
    • Handle: RePEc:arx:papers:1910.01044
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    References listed on IDEAS

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    Citations

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    Cited by:

    1. Maren Diane Schmeck & Stefan Schwerin, 2021. "The Effect of Mean-Reverting Processes in the Pricing of Options in the Energy Market: An Arithmetic Approach," Risks, MDPI, vol. 9(5), pages 1-19, May.
    2. Matteo Gardini & Edoardo Santilli, 2023. "A Heath-Jarrow-Morton framework for energy markets: a pragmatic approach," Papers 2305.01485, arXiv.org, revised Nov 2023.
    3. Thomas Deschatre & Olivier F'eron & Pierre Gruet, 2021. "A survey of electricity spot and futures price models for risk management applications," Papers 2103.16918, arXiv.org, revised Jul 2021.
    4. Piergiacomo Sabino, 2021. "Pricing Energy Derivatives in Markets Driven by Tempered Stable and CGMY Processes of Ornstein-Uhlenbeck Type," Papers 2103.13252, arXiv.org.
    5. Piergiacomo Sabino, 2021. "Normal Tempered Stable Processes and the Pricing of Energy Derivatives," Papers 2105.03071, arXiv.org.
    6. Roberto Baviera & Pietro Manzoni, 2024. "Fast and General Simulation of L\'evy-driven OU processes for Energy Derivatives," Papers 2401.15483, arXiv.org.

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    More about this item

    JEL classification:

    • C13 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Estimation: General
    • C14 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Semiparametric and Nonparametric Methods: General
    • C32 - Mathematical and Quantitative Methods - - Multiple or Simultaneous Equation Models; Multiple Variables - - - Time-Series Models; Dynamic Quantile Regressions; Dynamic Treatment Effect Models; Diffusion Processes; State Space Models
    • Q40 - Agricultural and Natural Resource Economics; Environmental and Ecological Economics - - Energy - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing

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