Energy Options in an HJM Framework

35 Pages Posted: 6 Mar 2005

See all articles by Bjarne Astrup Jensen

Bjarne Astrup Jensen

Copenhagen Business School - Department of Finance

Thomas Lyse Hansen

Copenhagen Business School - Department of Finance

Date Written: January 2005

Abstract

Options in energy markets often differ from standard options on futures by the fact that the underlying is a portfolio of futures rather than a single-delivery futures contract. Standard pricing formulas for options on single-delivery futures do not generalize to this case. There are similarities to pricing options on coupon bonds, although the number of single-delivery futures contracts in this underlying portfolio is usually much larger than the number of coupons on a coupon bond. This calls for easily implementable numerical approximations. We combine the HJM model approach in Miltersen and Schwartz (1998) with variants of the stochastic duration approach in Munk(1999) and find that this a very good approximation, in particular for at-the-money options.

Keywords: eneregy option, flow-forward-contracts, stochastic duration

JEL Classification: G13

Suggested Citation

Jensen, Bjarne Astrup and Hansen, Thomas Lyse, Energy Options in an HJM Framework (January 2005). Available at SSRN: https://ssrn.com/abstract=676864 or http://dx.doi.org/10.2139/ssrn.676864

Bjarne Astrup Jensen (Contact Author)

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

Thomas Lyse Hansen

Copenhagen Business School - Department of Finance ( email )

Solbjerg Plads 3
Frederiksberg, DK-2000
Denmark

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