Utility indifference pricing and hedging for structured contracts in energy markets

DOI10.1007/S00186-016-0569-6MaRDI QIDQ2014372zbMATH OpenOpenAlexDBLPWikidataFDO

Authors Giorgia Callegaro, Luciano Campi, Valeria Giusto, Tiziano Vargiolu

Publication date 11 August 2017

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

Copyright license Creative Commons Attribution 4.0 International

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)

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.

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Cited in

(6)

• Utility indifference valuation for non-smooth payoffs with an application to power derivatives
• A review of the operations literature on real options in energy
• A structural risk-neutral model for pricing and hedging power derivatives
• NUMERICAL HEDGING OF ELECTRICITY CONTRACTS USING DIMENSION REDUCTION
• Optimal management of pumped hydroelectric production with state constrained optimal control
• Any-utility neutral and indifference pricing and hedging

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