Asymptotic Pricing of Commodity Derivatives using Stochastic Volatility Spot Models

Samuel Hikspoors and Sebastian Jaimungal

Applied Mathematical Finance, 2008, vol. 15, issue 5-6, 449-477

Abstract: It is well known that stochastic volatility is an essential feature of commodity spot prices. By using methods of singular perturbation theory, we obtain approximate but explicit closed-form pricing equations for forward contracts and options on single- and two-name forward prices. The expansion methodology is based on a fast mean-reverting stochastic volatility driving factor and leads to pricing results in terms of constant volatility prices, their Deltas and their Delta-Gammas. Both the standard single-factor mean-reverting spot model and a two-factor generalization, in which the long-run mean is itself mean-reverting, are extended to include stochastic volatility and each is analysed in detail. The stochastic volatility corrections can be used to efficiently calibrate option prices and compute sensitivities.

Keywords: Commodity derivatives; stochastic volatility; spread options; singular perturbation methods (search for similar items in EconPapers)
Date: 2008
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Citations: View citations in EconPapers (15)

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DOI: 10.1080/13504860802170432

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