Utility indifference pricing and hedging for structured contracts in energy markets

Giorgia Callegaro, Luciano Campi (), Valeria Giusto and Tiziano Vargiolu
Additional contact information
Giorgia Callegaro: University of Padova
Luciano Campi: London School of Economics
Valeria Giusto: Phinergy S.r.l.s.

Mathematical Methods of Operations Research, 2017, vol. 85, issue 2, No 6, 265-303

Abstract: Abstract In this paper we study the pricing and hedging of structured products in energy markets, such as swing and virtual gas storage, using the exponential utility indifference pricing approach in a general incomplete multivariate market model driven by finitely many stochastic factors. The buyer of such contracts is allowed to trade in the forward market in order to hedge the risk of his position. We fully characterize the buyer’s utility indifference price of a given product in terms of continuous viscosity solutions of suitable nonlinear PDEs. This gives a way to identify reasonable candidates for the optimal exercise strategy for the structured product as well as for the corresponding hedging strategy. Moreover, in a model with two correlated assets, one traded and one nontraded, we obtain a representation of the price as the value function of an auxiliary simpler optimization problem under a risk neutral probability, that can be viewed as a perturbation of the minimal entropy martingale measure. Finally, numerical results are provided.

Keywords: Swing contract; Virtual storage contract; Utility indifference pricing; HJB equations; Viscosity solutions; Minimal entropy martingale measure (search for similar items in EconPapers)
Date: 2017
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Citations: View citations in EconPapers (4)

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Working Paper: Utility indifference pricing and hedging for structured contracts in energy markets (2017)
Working Paper: Utility indifference pricing and hedging for structured contracts in energy markets (2016)
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DOI: 10.1007/s00186-016-0569-6

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