Co-movements, option pricing and risk management: an application to WTI versus Brent spread options

Domenico De Giovanni (), Arturo Leccadito and Debora Loccisano
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Domenico De Giovanni: University of Calabria
Arturo Leccadito: University of Calabria
Debora Loccisano: Carleton University

Annals of Operations Research, 2024, vol. 336, issue 1, No 35, 1039-1061

Abstract: Abstract Co-moments of asset returns play a major role in financial contagion during crises. We study the properties of a particular specification of the generalized bivariate normal distribution which allows for co-volatility and co-skewness. With this probability distribution, formulae for single-name and exchange options can be evaluated quickly since they are based on one-dimensional integrals. We provide a very precise approximation formula for spread option prices and derive the corresponding greeks. We perform a day-to-day re-estimation of the probability distribution on a dataset of WTI vs Brent spread options, showing the ability of this specification to capture the salient empirical features observed in the market. Finally, we show the impact of co-movements on portfolio risk management.

Keywords: Contagion; Spread options; Co-moments; Value at risk; Expected Shortfall (search for similar items in EconPapers)
Date: 2024
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DOI: 10.1007/s10479-022-05059-7

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