The Effect of Mean-Reverting Processes in the Pricing of Options in the Energy Market: An Arithmetic Approach

Maren Diane Schmeck and Stefan Schwerin
Additional contact information
Maren Diane Schmeck: Center for Mathematical Economics, Bielefeld University, 33615 Bielefeld, Germany
Stefan Schwerin: Independent Researcher, 51065 Cologne, Germany

Risks, 2021, vol. 9, issue 5, 1-19

Abstract: In this paper we study the effect that mean-reverting components in the arithmetic dynamics of electricity spot price have on the price of a call option on a swap. Our model allows for seasonal effects, spikes, and negative values of the price of electricity. We show that for sufficiently large delivery periods of the swap contract, the error that one makes by neglecting some of the mean-reverting processes affecting the spot price evolution converges to zero. The decay rate is explicitly calculated. This is achieved by exploiting the additive structure of the electricity price process in order to determine an explicit closed-form formula for the price of the call on a swap. The theoretical analysis is then illustrated via a numerical example.

Keywords: electricity spot prices; multi-scale mean reversion; pricing error; jumps; delivery period; swaps (search for similar items in EconPapers)
JEL-codes: C G0 G1 G2 G3 K2 M2 M4 (search for similar items in EconPapers)
Date: 2021
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
https://www.mdpi.com/2227-9091/9/5/100/pdf (application/pdf)
https://www.mdpi.com/2227-9091/9/5/100/ (text/html)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:gam:jrisks:v:9:y:2021:i:5:p:100-:d:557359

Access Statistics for this article

Risks is currently edited by Mr. Claude Zhang

More articles in Risks from MDPI
Bibliographic data for series maintained by MDPI Indexing Manager ().