Minimal variance hedging of natural gas derivatives in exponential Lévy models: Theory and empirical performance

Christian-Oliver Ewald, Roy Nawar and Tak Kuen Siu

Energy Economics, 2013, vol. 36, issue C, 97-107

Abstract: We consider the problem of hedging European options written on natural gas futures, in a market where prices of traded assets exhibit jumps, by trading in the underlying asset. We provide a general expression for the hedging strategy which minimizes the variance of the terminal hedging error, in terms of stochastic integral representations of the payoffs of the options involved. This formula is then applied to compute hedge ratios for common options in various models with jumps, leading to easily computable expressions. As a benchmark we take the standard Black–Scholes and Merton delta hedges. We show that in natural gas option markets minimal variance hedging with underlying consistently outperform the benchmarks by quite a margin.

Keywords: Quadratic hedging; Jump-diffusion models; Natural gas options; Energy derivatives; Resource economics (search for similar items in EconPapers)
JEL-codes: G12 Q49 (search for similar items in EconPapers)
Date: 2013
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:eneeco:v:36:y:2013:i:c:p:97-107

DOI: 10.1016/j.eneco.2012.12.004

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