Utility indifference pricing and hedging for structured contracts in energy markets

Giorgia Callegaro, Luciano Campi, Valeria Giusto and Tiziano Vargiolu

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

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.

JEL-codes: C1 (search for similar items in EconPapers)
Date: 2017-04-01
New Economics Papers: this item is included in nep-ene and nep-upt
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Citations: View citations in EconPapers (4)

Published in Mathematical Methods of Operations Research, 1, April, 2017, 85(2), pp. 265-303. ISSN: 1432-2994

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Related works:
Journal Article: Utility indifference pricing and hedging for structured contracts in energy markets (2017)
Working Paper: Utility indifference pricing and hedging for structured contracts in energy markets (2016)
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