Valuing Energy Options in a One Factor Model Fitted to Forward Prices

  • Clewlow L
  • Strickland C
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Abstract

In this paper we develop a single-factor modeling framework which
is consistent with market observable forward prices and volatilities.
The model is a special case of the multi-factor model developed in
Clewlow and Strickland [1999b] and leads to analytical pricing formula
for standard options, caps, floors, collars and swaptions. We also
show how American style and exotic energy derivatives can be priced
using trinomial trees, which are constructed to be consistent with
the forward curve and volatility structure. We demonstrate the application
of the trinomial tree to the pricing of a European and American Asian
option. The analysis in this paper extends the results in Schwartz
[1997] and Amin, et al. [1995].

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Authors

  • Les Clewlow

  • Chris Strickland

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