Capturing the power options smile by an additive two-factor model for overlapping futures prices

Marco Piccirilli, Maren Diane Schmeck and Tiziano Vargiolu

Energy Economics, 2021, vol. 95, issue C

Abstract: In this paper we introduce an additive two-factor model for electricity futures prices based on Normal Inverse Gaussian Lévy processes, that fulfills a no-overlapping-arbitrage (NOA) condition. We compute European option prices by Fourier transform methods, introduce a specific calibration procedure that takes into account no-arbitrage constraints and fit the model to power option settlement prices of the European Energy Exchange (EEX). We show that our model is able to reproduce the different levels and shapes of the implied volatility (IV) profiles displayed by options with a variety of delivery periods.

Keywords: Volatility smile; Overlapping delivery periods; Arbitrage; Additive models; Power options; FFT (search for similar items in EconPapers)
JEL-codes: C13 C14 C32 G13 Q40 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (7)

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Related works:
Working Paper: Capturing the power options smile by an additive two-factor model for overlapping futures prices (2019)
Working Paper: Capturing the power options smile by an additive two-factor model for overlapping futures prices (2019)
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:95:y:2021:i:c:s0140988320303467

DOI: 10.1016/j.eneco.2020.105006

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