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Variance Optimal Hedging for discrete time processes with independent increments. Application to Electricity Markets

Author

Listed:
  • St'ephane Goutte

    (LAGA)

  • Nadia Oudjane

    (LAGA)

  • Francesco Russo

    (CERMICS, INRIA Rocquencourt, UMA)

Abstract

We consider the discretized version of a (continuous-time) two-factor model introduced by Benth and coauthors for the electricity markets. For this model, the underlying is the exponent of a sum of independent random variables. We provide and test an algorithm, which is based on the celebrated Foellmer-Schweizer decomposition for solving the mean-variance hedging problem. In particular, we establish that decomposition explicitely, for a large class of vanilla contingent claims. Interest is devoted in the choice of rebalancing dates and its impact on the hedging error, regarding the payoff regularity and the non stationarity of the log-price process.

Suggested Citation

  • St'ephane Goutte & Nadia Oudjane & Francesco Russo, 2012. "Variance Optimal Hedging for discrete time processes with independent increments. Application to Electricity Markets," Papers 1205.4089, arXiv.org.
    • Handle: RePEc:arx:papers:1205.4089
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    References listed on IDEAS

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    1. Martin Schweizer, 1995. "Variance-Optimal Hedging in Discrete Time," Mathematics of Operations Research, INFORMS, vol. 20(1), pages 1-32, February.
    2. Ales Cerny, 2004. "Dynamic programming and mean-variance hedging in discrete time," Applied Mathematical Finance, Taylor & Francis Journals, vol. 11(1), pages 1-25.
    3. Aleš Černý, 2007. "Optimal Continuous‐Time Hedging With Leptokurtic Returns," Mathematical Finance, Wiley Blackwell, vol. 17(2), pages 175-203, April.
    4. Flavio Angelini & Stefano Herzel, 2007. "Measuring the error of dynamic hedging: a Laplace transform approach," Quaderni del Dipartimento di Economia, Finanza e Statistica 33/2007, Università di Perugia, Dipartimento Economia.
    5. Friedrich Hubalek & Jan Kallsen & Leszek Krawczyk, 2006. "Variance-optimal hedging for processes with stationary independent increments," Papers math/0607112, arXiv.org.
    6. St'ephane Goutte & Nadia Oudjane & Francesco Russo, 2009. "Variance Optimal Hedging for continuous time processes with independent increments and applications," Papers 0912.0372, arXiv.org.
    7. Föllmer, H. & Schweizer, M., 1989. "Hedging by Sequential Regression: an Introduction to the Mathematics of Option Trading," ASTIN Bulletin, Cambridge University Press, vol. 19(S1), pages 29-42, November.
    8. Flavio Angelini & Stefano Herzel, 2010. "Explicit formulas for the minimal variance hedging strategy in a martingale case," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 33(1), pages 63-79, May.
    9. Fred Espen Benth & Jan Kallsen & Thilo Meyer-Brandis, 2007. "A Non-Gaussian Ornstein-Uhlenbeck Process for Electricity Spot Price Modeling and Derivatives Pricing," Applied Mathematical Finance, Taylor & Francis Journals, vol. 14(2), pages 153-169.
    10. Emmanuel Temam & Emmanuel Gobet, 2001. "Discrete time hedging errors for options with irregular payoffs," Finance and Stochastics, Springer, vol. 5(3), pages 357-367.
    11. Fred Espen Benth & Giulia Di Nunno & Arne Løkka & Bernt Øksendal & Frank Proske, 2003. "Explicit Representation of the Minimal Variance Portfolio in Markets Driven by Lévy Processes," Mathematical Finance, Wiley Blackwell, vol. 13(1), pages 55-72, January.
    12. Cox, John C. & Ross, Stephen A. & Rubinstein, Mark, 1979. "Option pricing: A simplified approach," Journal of Financial Economics, Elsevier, vol. 7(3), pages 229-263, September.
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    Cited by:

    1. St'ephane Goutte & Nadia Oudjane & Francesco Russo, 2013. "Variance optimal hedging for continuous time additive processes and applications," Papers 1302.1965, arXiv.org.
    2. Boroumand, Raphaël Homayoun & Goutte, Stéphane & Porcher, Simon & Porcher, Thomas, 2015. "Hedging strategies in energy markets: The case of electricity retailers," Energy Economics, Elsevier, vol. 51(C), pages 503-509.
    3. Ke Nian & Thomas F. Coleman & Yuying Li, 2018. "Learning minimum variance discrete hedging directly from the market," Quantitative Finance, Taylor & Francis Journals, vol. 18(7), pages 1115-1128, July.
    4. Julien Chevallier & Stéphane Goutte, 2017. "Estimation of Lévy-driven Ornstein–Uhlenbeck processes: application to modeling of $$\hbox {CO}_2$$ CO 2 and fuel-switching," Annals of Operations Research, Springer, vol. 255(1), pages 169-197, August.
    5. Fred Benth & Nils Detering, 2015. "Pricing and hedging Asian-style options on energy," Finance and Stochastics, Springer, vol. 19(4), pages 849-889, October.
    6. St'ephane Goutte & Nadia Oudjane & Francesco Russo, 2009. "Variance Optimal Hedging for continuous time processes with independent increments and applications," Papers 0912.0372, arXiv.org.
    7. Debbie Dupuis, Geneviève Gauthier, and Fréderic Godin, 2016. "Short-term Hedging for an Electricity Retailer," The Energy Journal, International Association for Energy Economics, vol. 0(Number 2).

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