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An Optimal Rule for Switching over to Renewable fuels with Lower Price Volatility: A Case of Jump Diffusion Process

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  • Sardana, Kavita
  • Bhattacharya, Subhra K.

Abstract

This study investigates the optimal switching boundary to a renewable fuel when oil prices exhibit continuous random fluctuations along with occasional discontinuous jumps. In this paper, oil prices are modeled to follow jump diffusion processes. A completeness result is derived. Given that the market is complete the value of a contingent claim is risk neutral expectation of the discounted pay off process. Using the contingent claim analysis of investment under uncertainty, the Hamilton-Jacobi-Bellman (HJB) equation is derived for finding value function and optimal switching boundary. We get a mixed differential-difference equation which would be solved using numerical methods.

Suggested Citation

  • Sardana, Kavita & Bhattacharya, Subhra K., 2011. "An Optimal Rule for Switching over to Renewable fuels with Lower Price Volatility: A Case of Jump Diffusion Process," 2011 Annual Meeting, July 24-26, 2011, Pittsburgh, Pennsylvania 103926, Agricultural and Applied Economics Association.
    • Handle: RePEc:ags:aaea11:103926
    DOI: 10.22004/ag.econ.103926
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    References listed on IDEAS

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    1. Lee, Yen-Hsien & Hu, Hsu-Ning & Chiou, Jer-Shiou, 2010. "Jump dynamics with structural breaks for crude oil prices," Energy Economics, Elsevier, vol. 32(2), pages 343-350, March.
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