Utility indifference pricing and hedging for structured contracts in energy markets

DOI10.1007/S00186-016-0569-6zbMATH Open1414.91363DBLPjournals/mmor/CallegaroCGV17arXiv1407.7725OpenAlexW2142565351WikidataQ59605739 ScholiaQ59605739MaRDI QIDQ2014372FDOQ2014372

Luciano Campi, Valeria Giusto, Tiziano Vargiolu, Giorgia Callegaro

Publication date: 11 August 2017

Published in: Mathematical Methods of Operations Research (Search for Journal in Brave)

Abstract: In this paper we study the pricing and hedging of structured products in energy markets, such as swing and virtual gas storage, using the exponential utility indifference pricing approach in a general incomplete multivariate market model driven by finitely many stochastic factors. The buyer of such contracts is allowed to trade in the forward market in order to hedge the risk of his position. We fully characterize the buyer's utility indifference price of a given product in terms of continuous viscosity solutions of suitable nonlinear PDEs. This gives a way to identify reasonable candidates for the optimal exercise strategy for the structured product as well as for the corresponding hedging strategy. Moreover, in a model with two correlated assets, one traded and one nontraded, we obtain a representation of the price as the value function of an auxiliary simpler optimization problem under a risk neutral probability, that can be viewed as a perturbation of the minimal entropy martingale measure. Finally, numerical results are provided.

Full work available at URL: https://arxiv.org/abs/1407.7725

zbMATH Keywords

viscosity solutionsutility indifference pricingHJB equationsminimal entropy martingale measureswing contractvirtual storage contract

Mathematics Subject Classification ID

Derivative securities (option pricing, hedging, etc.) (91G20) Numerical methods (including Monte Carlo methods) (91G60) Generalizations of martingales (60G48) Viscosity solutions to Hamilton-Jacobi equations in optimal control and differential games (49L25)

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Cited In (3)

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• A review of the operations literature on real options in energy

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