Quantitative Energy Finance: Modeling, Pricing, and Hedging in Energy and Commodity Markets PDF
Preview Quantitative Energy Finance: Modeling, Pricing, and Hedging in Energy and Commodity Markets
Fred Espen Benth Valery A. Kholodnyi Peter Laurence Editors Quantitative Energy Finance Modeling, Pricing, and Hedging in Energy and Commodity Markets Quantitative Energy Finance Fred Espen Benth • Valery A. Kholodnyi • Peter Laurence Editors Quantitative Energy Finance Modeling, Pricing, and Hedging in Energy and Commodity Markets 123 Editors FredEspenBenth ValeryA.Kholodnyi CenterofMathematicsforApplications VerbundTradingAG UniversityofOslo Vienna,Austria Oslo,Norway PeterLaurence DipartimentodiMatematica UniversitydiRoma,LaSapienza Rome,Italy ISBN978-1-4614-7247-6 ISBN978-1-4614-7248-3(eBook) DOI10.1007/978-1-4614-7248-3 SpringerNewYorkHeidelbergDordrechtLondon LibraryofCongressControlNumber:2013940060 ©SpringerScience+BusinessMediaNewYork2014 Thisworkissubjecttocopyright.AllrightsarereservedbythePublisher,whetherthewholeorpartofthematerialisconcerned, specificallytherightsoftranslation,reprinting,reuseofillustrations,recitation,broadcasting,reproductiononmicrofilmsorinany otherphysicalway,andtransmissionorinformationstorageandretrieval,electronicadaptation,computersoftware,orbysimilaror dissimilarmethodologynowknownorhereafterdeveloped.Exemptedfromthislegalreservationarebriefexcerptsinconnectionwith reviewsorscholarlyanalysisormaterialsuppliedspecificallyforthepurposeofbeingenteredandexecutedonacomputersystem,for exclusiveusebythepurchaserofthework.Duplicationofthispublicationorpartsthereofispermittedonlyundertheprovisionsof theCopyrightLawofthePublisher’slocation,initscurrentversion,andpermissionforusemustalwaysbeobtainedfromSpringer. PermissionsforusemaybeobtainedthroughRightsLinkattheCopyrightClearanceCenter.Violationsareliabletoprosecutionunder therespectiveCopyrightLaw. Theuseofgeneraldescriptivenames,registerednames,trademarks,servicemarks,etc.inthispublicationdoesnotimply,eveninthe absenceofaspecificstatement,thatsuchnamesareexemptfromtherelevantprotectivelawsandregulationsandthereforefreefor generaluse. Whiletheadviceandinformationinthisbookarebelievedtobetrueandaccurateatthedateofpublication,neithertheauthorsnor theeditorsnorthepublishercanacceptanylegalresponsibilityforanyerrorsoromissionsthatmaybemade.Thepublishermakes nowarranty,expressorimplied,withrespecttothematerialcontainedherein. Printedonacid-freepaper SpringerispartofSpringerScience+BusinessMedia(www.springer.com) Foreword Thecombinationofmathematicaltheory,numericalsimulationandapplicationsisthecoremissionofthe Wolfgang Pauli Institute. As a private institution run by tenured universityprofessorsthe WPI rendersa servicetothecommunitybyimplementingandco-funding“thematicprogrammes”:thegoalisthatseveral internationalleadingexpertsinafieldofresearchwith“interdisciplinary”aspectsjoinforcesandorganize workshopsandconferencesaroundatheme.“Financialmathematics”isoneofthesefieldsandwhenPeter Laurence,myformercolleagueatCourantInstitute,cameupwiththeideaofaprogrammetogetherwith ValeryKholodnyiandFredBenth,theapprovaloftheproposalbytheWPIgeneralassembly(consisting of ERC grant holders, START and Wittgenstein awardees, etc.) and the “ok” of the WPI International ScientificBoard(consistingofscientistslikePierre-LouisLions)wereimmediate.Duetoitstremendous successthisprogrammeiscontinuouslyprolongedandIamhappyandgratefulthatFred,PeterandValery keepongoing. Vienna,Austria NorbertMauser v Preface Energyisoffundamentalimportanceinthemodernsociety.From2010theWolfgangPauliInstitute(WPI) inViennahasorganizedaspecialthematicprogramcalled“Financialengineeringforenergyassetmanage- mentandhedgingincommoditymarkets(ENERGY-10)”,whichhashaditsfocusonriskmanagementin theenergysector.Thisvolumecollectscontributionsfromsomeoftheactiveparticipantsinthisthematic program,showingtheresearchfrontiersofthisexcitingbranchoffinancialmathematicsandstochastics. Togivesomeperspective,the“thematicprograms”werelaunchedbyNorbertMauser,theDirectorof WPI. Norbertinvited one of us (Peter) to submit a proposalfor such a thematic programin 2009. Peter invitedFredandValeryto joinhimasco-organizersofthespecialprogram,whichkicked-offinJanuary 2010.The programhassince thenorganizedtwoconferencesonenergyfinance(onein2011andonein 2012)aswellasseveralmini-workshopsheldbyleadingexpertsintheirrespectivespecializedfields. The thematic programsare special in that registrationis free, participantsthereby obtainingaccess to talksfromleadingexpertswhoalsogivepresentationsinexpensiveexecutiveconferences,withtriple-digit registrationfees.Theatmosphereisveryfriendlyandcongenial.Manynewcollaborationsandfriendships areborninsuchanatmosphere,andthiswasindeedverymuchthespiritinwhichthethematicprograms werelaunchedbyNorbert,whomwethankforgivingustheopportunitytoorganizethishighlysuccessful initiative. Inthisvolumewehavecollectedcontributionsfromresearcherswhohavegivenmini-coursesorhave presented talks at the first conference organized in the program taking place at the WPI in July 2011. Some chaptersserve as lecture notes to mini-workshops,while other chaptersreflect presentationsfrom the conference.The conference was co-sponsoredby the Centre of Mathematics for Applications at the UniversityofOsloandbyVERBUNDTrading,alongwiththegeneroussupportofWPI. We would like to mention that a new thematic program called “Mathematical finance: Applications to energy markets, risk management and pricing of derivatives (FINANCE-12)” started in 2012 and is organizedbyustogetherwithAlmutVeraartatImperialCollege. WewishtothankHannahBracken,CatrionaByrne,BrianFosterandNicholasPhilipsonforgivingus theopportunitytopublishthisvolumeatSpringerVerlag.Furthermore,wearegratefulforallthetechnical supportandassistancefromtheSpringergroupinNewYork.FredEspenBenthgreatlyacknowledgesthe financialsupportfromtheproject“EMMOS”(EnergyMarkets:Modelling,OptimizationandSimulation) fundedbytheNorwegianResearch CouncilundertheEvita program.He also thankshiswifeJu¯rate˙ and daughterJuliaforalltheloveandfun.ValeryA.KholodnyithankshiswifeLarisaandhissonsNikitaand Ilyafortheirlove,patienceandcare.PeterLaurencethankshiswifeMagdalenaforhersweetcompanion- shipandsupport. Wehaveseparatedtheproceedingsintothreemainparts:surveys,energyspotmodellingandpricingof derivatives.PartIconsistsoffourchapters: vii viii Preface • Rene´ A¨ıd presents an in-depth and extensive survey on optimal investments in electricity generation. Thechapterprovidesthereaderwithanoverviewontheexistingliteratureoninvestmentdecisionsin thecontextofpowerproduction.Thischapterservesaslecturenotesfromthetwo-daymini-workshop givenbyRene´A¨ıdattheWPIinJanuary2012. • Theveryfirstmini-workshopinthisthematicprogramwasgivenatWPIbyRene´ CarmonainJanuary 2010. In the chapter written together with Michael Coulon, structural models in energy markets are presented.The authorsprovidea well-writtenand entertainingsurveyon commoditymarketsand the challengesinmodellingpricesinthese.Structuralstochasticmodelsareintroducedandanalysed,and detailsonanalyticforwardpricingarepresented. • Inenergymarketsthepricedynamicsistypicallyofanon-Gaussiannature,andvaluationofderivatives callsformethodsgoingbeyondtheBlackandScholesformula.InJanuary2012ErnstEberleinpresented a mini-course on Fourier-based methods for pricing options in markets where the price dynamics is drivenbyjumpprocesses.Thistheoryisextensivelydevelopedintraditionalfinancialmarketsasfixed incomeandcredit.ThechapterbyErnstEberleinservesasthelecturenotesfromhismini-workshopon thetopicandprovidesthereaderwithanextensiveintroductionandanalysisofthesemethods,fullof detailsandexampleswritteninanengagingway.Thistheoryishighlyapplicableforenergymarkets. • A typical feature of energy markets is the abundance of exotic derivatives much more sophisticated in their specificationsthan more traditionalderivativesfoundin other markets. Many of these energy derivatives go under the umbrella of so-called swing options. Jukka Lempa presents a survey on the variousmathematicalapproachestostudytheproblemofpricingandoptimalexecutionofsuchoptions. Itinvolvesvarioustechniquescollectedfromstochasticcontroltheory,presentedinahighlyaccessible waybytheauthor. Thesecondpartofthisvolumeconsistsofthreechaptersonthebasicbutchallengingproblemofenergy spotpricemodelling: • JoannaJanczuraandRafalWeronpresentageneralclassofMarkov-regime-switchingmodelforelec- tricity pricesanddiscuss theproblemof inference.Anextensiveempiricalstudyispresentedforspot pricescollectedattwoelectricityexchanges. • Almut and Luitgard Veraart proposea new class of modelsfor the dynamicsof hourly spotprices of electricity. The so-called Le´vy semistationary models are extended to a multivariate setting, and an extensiveempiricalstudyisperformed. • Valery A. Kholodnyipresentsand furtherextendsthe class of hisnon-Markovianspot priceprocesses to allow for both positive and negative prices, as well as spikes in both the upward and downward directions. The forward price dynamics is analysed within this class of models as well. This chapter servesalso as lecturenotesforpartsofthetwo-daymini-workshopgivenbythe authorattheWPI in October2011. Thelastpartofthisvolumecontainsfourchaptersonproblemsrelatedtoenergyderivatives. • A´lvaro Cartea and Pablo Villaplana provide a detailed analysis on the main determinants of the risk premiumandtheforwardpriceevolutioninelectricitymarkets.Astheclassicalspot-forwardrelation- shipbreaksdowninelectricitymarketsduetonon-storability,thesearefundamentalissuesinderivative pricinginpowermarkets.TheauthorsbasetheiranalysisondatafromEuropeanpowermarkets. • ThiloMeyer-BrandisandMichaelMorganproposeabivariatespotmodelforelectricityandgasusing dynamicLe´vy copulasto capturethe dependencystructure. Theyhave spark spread optionpricing in mindandderiveanalyticpricingexpressionsbasedonFouriertransformmethods,asdescribedbyErnst EberleininChap.3.DatafromtheUKisusedinanempiricalcasestudy. • PeterLaurence,RicardoPignolandEstebanTabakpresentanovelapproachtodensityestimationtaking constraintsintoaccount.Themethodisgenerallyapplicableto a hugevarietyofproblemsinscience, buthereexamplesfromrecoveringthedensityfromspreadoptionpricesareconsidered. Preface ix • FredEspenBenth,RichardBiegler-Ko¨nigandRu¨digerKieselanalysetheinfluenceofforward-looking informationinelectricitymarketsoncallandputoptionsonforwardcontracts.Themathematicalanal- ysis is based on the theoryfor enlargementof filtrations, and stylized examplesare givento illustrate thefindings. We hopethatthe readerwill enjoythe variouschaptersasmuchas we haveenjoyedlisteningto, dis- cussingwithandreadingthecontributionsfromtheauthors. Oslo,Norway FredEspenBenth Vienna,Austria ValeryA.Kholodnyi Rome,Italy PeterLaurence
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