Energy-based assets: modelling, option pricing and delta hedging with transaction costs Online publication date: Sun, 26-Dec-2010
by Sovan Mitra
International Journal of Sustainable Economy (IJSE), Vol. 3, No. 1, 2011
Abstract: The growing significance of climate change and carbon financing means it is becoming increasingly important to generically model energy-based assets in a more theoretically consistent and realistic approach. A fundamental feature is supply-demand imbalances and this is modelled by deterministic sinusoidal functions on multiple time scales. This is unrealistic and theoretically inconsistent with scientific and financial models. We propose a new generic model for energy-based assets using Ornstein–Uhlenbeck processes on multiple time scales, which captures supply-demand imbalances in a more theoretically consistent and realistic manner. We analyse its properties and derive closed form solutions to European option prices on the underlying spot and futures processes. We derive a closed form analytic equation for delta hedging options under transaction costs using a perturbation analysis. We conduct numerical experiments on our model by calibrating it to Nord Pool electricity data and executing Monte Carlo simulation over 10,000 sample paths.
Existing subscribers:
Go to Inderscience Online Journals to access the Full Text of this article.
If you are not a subscriber and you just want to read the full contents of this article, buy online access here.Complimentary Subscribers, Editors or Members of the Editorial Board of the International Journal of Sustainable Economy (IJSE):
Login with your Inderscience username and password:
Want to subscribe?
A subscription gives you complete access to all articles in the current issue, as well as to all articles in the previous three years (where applicable). See our Orders page to subscribe.
If you still need assistance, please email subs@inderscience.com
Our Blog 
Follow us on Twitter 
Visit us on Facebook