Optimal Hedging Strategies for Options in Electricity Futures Markets

22 Pages Posted: 17 Apr 2021 Last revised: 1 Jul 2021

See all articles by Markus Hess

Markus Hess

Université Libre de Bruxelles (ULB)

Date Written: April 13, 2021

Abstract

In this paper, we derive optimal hedging strategies for options in electricity futures markets. Optimality is measured in terms of minimal variance and the associated minimal variance hedging portfolios are obtained by a stochastic maximum principle. Our explicit results are particularly useful for electricity retailers, who have sold an option to a client, and now want to hedge the payoff of this option by investing into an electricity futures and into the issued option itself. Another innovative aspect of the paper lies in the derivation of the time dynamics of the stochastic option price process by Malliavin calculus methods and the Clark-Ocone formula. We also apply our theoretical results to several practical examples. Our investigations are based upon the popular arithmetic multi-factor electricity spot price model proposed by Benth, Kallsen & Meyer-Brandis (Appl. Math. Finance 14(2):153-169, 2007).

Keywords: minimal variance hedging, portfolio optimization, stochastic maximum principle, stochastic control, stochastic differential equation, Malliavin calculus, Clark-Ocone formula, electricity spot/forward/futures price model, option pricing

JEL Classification: C02, C61, D52, D81, G11, G12, G13

Suggested Citation

Hess, Markus, Optimal Hedging Strategies for Options in Electricity Futures Markets (April 13, 2021). Available at SSRN: https://ssrn.com/abstract=3825720 or http://dx.doi.org/10.2139/ssrn.3825720

Markus Hess (Contact Author)

Université Libre de Bruxelles (ULB) ( email )

CP 210 Boulevard du Triomphe
Brussels, Brussels 1050
Belgium

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