Pricing energy futures options: The role of seasonality and liquidity

Wenting Chen, Zhao Yang and Xin-Jiang He

Energy Economics, 2025, vol. 149, issue C

Abstract: In this paper, we propose an enhanced pricing framework for energy derivatives by incorporating seasonal effects and liquidity risks into the traditional two-factor model. The main theoretical challenge lies in deriving a tractable semi-analytical solution for the price of energy futures options under this enhanced model specification, which we have successfully achieved through advanced analytical techniques. Our solution demonstrates superior computational efficiency compared to the Monte-Carlo method, and greatly facilitates the model calibration process. Empirical results reveal that the proposed model outperforms both the standard two-factor model and the model with a seasonal-only specification, validating the importance of jointly modeling seasonal factors and liquidity risks for pricing energy futures options.

Keywords: Energy futures option; Seasonality; Liquidity risk; Option pricing (search for similar items in EconPapers)
JEL-codes: C02 C61 C63 G13 G17 Q47 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:149:y:2025:i:c:s014098832500564x

DOI: 10.1016/j.eneco.2025.108737

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