Hedging electricity swaptions using partial integro-differential equations

Peter Hepperger

Stochastic Processes and their Applications, 2012, vol. 122, issue 2, 600-622

Abstract: The basic contracts traded on energy exchanges are swaps involving the delivery of electricity for fixed-rate payments over a certain period of time. The main objective of this article is to solve the quadratic hedging problem for European options on these swaps, known as electricity swaptions. We consider a general class of Hilbert space valued exponential jump-diffusion models. Since the forward curve is an infinite-dimensional object, but only a finite set of traded contracts are available for hedging, the market is inherently incomplete. We derive the optimization problem for the quadratic hedging problem under the risk neutral measure and state a representation of its solution, which is the starting point for numerical algorithms.

Keywords: Swaptions; Quadratic hedging; Hilbert space valued jump-diffusion; Infinite-dimensional stochastic analysis; Partial integro-differential equation (search for similar items in EconPapers)
Date: 2012
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Citations: View citations in EconPapers (1)

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DOI: 10.1016/j.spa.2011.09.005

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