Valuing commodity options and futures options with changing economic conditions

Kun Fan, Yang Shen, Tak Kuen Siu and Rongming Wang

Economic Modelling, 2015, vol. 51, issue C, 524-533

Abstract: A model for valuing a European-style commodity option and a futures option is discussed with a view to incorporating the impact of changing hidden economic conditions on commodity price dynamics. The proposed model may be thought of as an extension to the Gibson–Schwartz two-factor model, where the model parameters vary when the hidden state of an economy switches. A semi-analytical approach to valuing commodity options and futures options is adopted, where the closed-form expressions for the characteristic functions of the logarithmic commodity price and futures price are derived. A fast Fourier transform (FFT) approach is then applied to provide a practical and efficient way to evaluate the option prices. Real data studies and numerical examples are used to illustrate the practical implementation of the model.

Keywords: Commodity options; Futures options; Regime-switching; Gibson–Schwartz two-factor model; Fast Fourier transform (search for similar items in EconPapers)
Date: 2015
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecmode:v:51:y:2015:i:c:p:524-533

DOI: 10.1016/j.econmod.2015.09.006

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