Minimal Variance Hedging of Natural Gas Derivatives in Exponential Levy Models: Theory and Empirical Performance

33 Pages Posted: 13 Sep 2012

See all articles by Christian Oliver Ewald

Christian Oliver Ewald

University of Glasgow; Høgskole i Innlandet

Roy Nawar

University of Sydney

Tak-Kuen Siu

Macquarie University, Macquarie Business School

Date Written: September 12, 2012

Abstract

We consider the problem of hedging European options written on natural gas futures, in a market where prices of traded assets exhibit jumps, by trading in the underlying asset. We provide a general expression for the hedging strategy which minimizes the variance of the terminal hedging error, in terms of stochastic integral representations of the payoffs of the options involved. This formula is then applied to compute hedge ratios for common options in various models with jumps, leading to easily computable expressions. As a benchmark we take the standard Black-Scholes-Merton delta hedges. We show that in natural gas option markets minimal variance hedging with underlying consistently outperform the benchmarks by quite a margin.

Keywords: Quadratic hedging, jump-diffusions models, natural gas options, energy derivatives, resource economics

JEL Classification: G12, Q49

Suggested Citation

Ewald, Christian Oliver and Nawar, Roy and Siu, Tak-Kuen, Minimal Variance Hedging of Natural Gas Derivatives in Exponential Levy Models: Theory and Empirical Performance (September 12, 2012). Available at SSRN: https://ssrn.com/abstract=2145306 or http://dx.doi.org/10.2139/ssrn.2145306

Christian Oliver Ewald (Contact Author)

University of Glasgow ( email )

Adam Smith Building
Glasgow, Scotland G12 8RT
United Kingdom

Høgskole i Innlandet ( email )

Lillehammer, 2624
Norway

Roy Nawar

University of Sydney ( email )

University of Sydney
Sydney, NSW 2006
Australia

Tak-Kuen Siu

Macquarie University, Macquarie Business School

New South Wales 2109
Australia

Do you have negative results from your research you’d like to share?

Paper statistics

Downloads
172
Abstract Views
1,287
Rank
314,422
PlumX Metrics