Arbitrage free cointegrated models in gas and oil future markets

arXiv0712.3537MaRDI QIDQ6207900FDOQ6207900

Grégory Benmenzer, Emmanuel Gobet, Céline Jérusalem

Publication date: 20 December 2007

Abstract: In this article we present a continuous time model for natural gas and crude oil future prices. Its main feature is the possibility to link both energies in the long term and in the short term. For each energy, the future returns are represented as the sum of volatility functions driven by motions. Under the risk neutral probability, the motions of both energies are correlated Brownian motions while under the historical probability, they are cointegrated by a Vectorial Error Correction Model. Our approach is equivalent to defining the market price of risk. This model is free of arbitrage: thus, it can be used for risk management as well for option pricing issues. Calibration on European market data and numerical simulations illustrate well its behavior.

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