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A Continuous Time Model to Price Commodity-Based Swing Options

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  • M. Dahlgren

Abstract

On the commodity market there exist contracts which give the holder multiple opportunities to adjust delivery of the underlying commodity. These contracts are often named “Swing” or “take-or-pay” options. They are especially common on the electricity market. In this paper the price of a Swing option on commodities is investigated under the additional constraint of a recovery time between two different exercise times. We give an explicit characterization of the price function as the value function of a continuous stochastic impulse control problem and prove existence of an optimal control. We investigate the connection between the price function and the solution of a system of quasi-variational inequalities. Finally, we present a numerical algorithm for solving the quasi-variational inequalities, and give some numerical examples. Copyright Springer Science + Business Media, Inc. 2005

Suggested Citation

  • M. Dahlgren, 2005. "A Continuous Time Model to Price Commodity-Based Swing Options," Review of Derivatives Research, Springer, vol. 8(1), pages 27-47, June.
    • Handle: RePEc:kap:revdev:v:8:y:2005:i:1:p:27-47
    DOI: 10.1007/s11147-005-1006-9
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    References listed on IDEAS

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    1. Martin Dahlgren & Ralf Korn, 2005. "The Swing Option On The Stock Market," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 8(01), pages 123-139.
    2. Thompson, Andrew C., 1995. "Valuation of Path-Dependent Contingent Claims with Multiple Exercise Decisions over Time: The Case of Take-or-Pay," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 30(2), pages 271-293, June.
    3. Ibáñez, Alfredo & Zapatero, Fernando, 2004. "Monte Carlo Valuation of American Options through Computation of the Optimal Exercise Frontier," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 39(2), pages 253-275, June.
    4. Martin Dahlgren, 2005. "Optimal sale strategies in illiquid markets," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 61(2), pages 173-190, June.
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    Cited by:

    1. Hendrik Kohrs & Hermann Mühlichen & Benjamin R. Auer & Frank Schuhmacher, 2019. "Pricing and risk of swing contracts in natural gas markets," Review of Derivatives Research, Springer, vol. 22(1), pages 77-167, April.
    2. J. Lars Kirkby & Shi-Jie Deng, 2019. "Swing Option Pricing By Dynamic Programming With B-Spline Density Projection," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(08), pages 1-53, December.
    3. Olivier Feron & Pierre Gruet, 2020. "Estimation of the number of factors in a multi-factorial Heath-Jarrow-Morton model in electricity markets," Working Papers hal-02880824, HAL.
    4. Marcus Eriksson & Jukka Lempa & Trygve Nilssen, 2014. "Swing options in commodity markets: a multidimensional Lévy diffusion model," Mathematical Methods of Operations Research, Springer;Gesellschaft für Operations Research (GOR);Nederlands Genootschap voor Besliskunde (NGB), vol. 79(1), pages 31-67, February.
    5. Nicolas Essis-Breton & Patrice Gaillardetz, 2020. "Fast Lower and Upper Estimates for the Price of Constrained Multiple Exercise American Options by Single Pass Lookahead Search and Nearest-Neighbor Martingale," Papers 2002.11258, arXiv.org.

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