A numerical algorithm for pricing electricity derivatives for jump-diffusion processes based on continuous time lattices

Claudio Albanese, Harry Lo and Stathis Tompaidis

European Journal of Operational Research, 2012, vol. 222, issue 2, 361-368

Abstract: We present a numerical algorithm for pricing derivatives on electricity prices. The algorithm is based on approximating the generator of the underlying price process on a lattice of prices, resulting in an approximation of the stochastic process by a continuous time Markov chain. We numerically study the rate of convergence of the algorithm for the case of the Merton jump-diffusion model and apply the algorithm to calculate prices and sensitivities of both European and Bermudan electricity derivatives when the underlying price follows a stochastic process which exhibits both fast mean-reversion and jumps of large magnitude.

Keywords: Finance; Dynamic programming; Continuous time Markov chains; Electricity derivatives (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (10)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:ejores:v:222:y:2012:i:2:p:361-368

DOI: 10.1016/j.ejor.2012.04.030

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