Equilibrium pricing of European crude oil options with stochastic behaviour and jump risks

Zhihao Hu, Ben-Zhang Yang, Xin-Jiang He and Jia Yue

Mathematics and Computers in Simulation (MATCOM), 2024, vol. 219, issue C, 212-230

Abstract: In this paper, we investigate the pricing of European crude oil options under nonlinear dynamics with stochastic behaviour and jump risks, incorporating the features of arising convenience yield of crude oil and potential extreme fluctuation in the dynamics of crude oil prices. We present a closed-form solution to European crude oil option prices under an incomplete market setting, after deriving the pricing kernel with the equilibrium method and determining the risk neutral dynamics of crude oil prices. We extend our model to a mean-reverting stochastic volatility case, which also admits an analytical formula for the equilibrium price of European crude-oil options. Finally, our model is shown to be consistent with a number of interesting facts documented in the recent literature.

Keywords: Crude oil; Equilibrium option pricing; Stochastic convenience yield; Jump risk; Stochastic volatility; Nonlinear dynamics (search for similar items in EconPapers)
Date: 2024
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:matcom:v:219:y:2024:i:c:p:212-230

DOI: 10.1016/j.matcom.2023.12.020

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