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A First-Order BSPDE for Swing Option Pricing: Classical Solutions

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  • Christian Bender
  • Nikolai Dokuchaev

Abstract

In Bender and Dokuchaev (2013), we studied a control problem related to swing option pricing in a general non-Markovian setting. The main result there shows that the value process of this control problem can be uniquely characterized in terms of a first order backward SPDE and a pathwise differential inclusion. In the present paper we additionally assume that the cashflow process of the swing option is left-continuous in expectation (LCE). Under this assumption we show that the value process is continuously differentiable in the space variable that represents the volume which the holder of the option can still exercise until maturity. This gives rise to an existence and uniqueness result for the corresponding backward SPDE in a classical sense. We also explicitly represent the space derivative of the value process in terms of a nonstandard optimal stopping problem over a subset of predictable stopping times. This representation can be applied to derive a dual minimization problem in terms of martingales.

Suggested Citation

  • Christian Bender & Nikolai Dokuchaev, 2014. "A First-Order BSPDE for Swing Option Pricing: Classical Solutions," Papers 1402.6444, arXiv.org, revised Nov 2014.
    • Handle: RePEc:arx:papers:1402.6444
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    References listed on IDEAS

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    1. David B. Brown & James E. Smith & Peng Sun, 2010. "Information Relaxations and Duality in Stochastic Dynamic Programs," Operations Research, INFORMS, vol. 58(4-part-1), pages 785-801, August.
    2. M. Basei & A. Cesaroni & T. Vargiolu, 2013. "Optimal exercise of swing contracts in energy markets: an integral constrained stochastic optimal control problem," Papers 1307.1320, arXiv.org.
    3. Christian Bender & Nikolai Dokuchaev, 2013. "A First-Order BSPDE for Swing Option Pricing," Papers 1305.3988, arXiv.org.
    4. Nikolai Dokuchaev, 2013. "Continuously Controlled Options: Derivatives With Added Flexibility," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 16(01), pages 1-23.
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