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How Slow Mean Reversion Affects Energy Forward Option Pricing

Article arXiv papers · Author: Maren Diane Schmeck
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Summary

The document examines option pricing and hedging on energy forwards when spot prices follow a geometric multifactor model with several mean-reversion rates. It focuses on how slow mean-reverting components affect valuation and hedge quality.

The authors derive upper and lower bounds on pricing error when low mean-reversion rates are ignored. The excerpt does not provide the model’s detailed assumptions, the bounds themselves, or numerical examples, so it offers a focused description of the issue rather than enough information to assess the size of the error in a particular market.

Key ideas

  • Energy spot prices can be modeled with multiple mean-reversion rates.
  • Slow mean reversion can matter when pricing and hedging options on forwards.
  • The study bounds the error caused by omitting low mean-reversion rates.

Tags

CommoditiesOptionsDerivatives pricingMean reversion
Full text
# Pricing options on forwards in energy markets: the role of mean reversion's speed


# Pricing options on forwards in energy markets: the role of mean reversion's speed









Consider the problem of pricing options on forwards in energy markets, when spot prices follow a geometric multi-factor model in which several rates of mean reversion appear. In this paper we investigate the role played by slow mean reversion when pricing and hedging options. In particular, we determine both upper and lower bounds for the error one makes neglecting low rates of mean reversion in the spot price dynamics.

Shown in full with attribution under the source's licence. Licence: abstract CC0

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.