Optimal Hedging Strategies for Options in Electricity Futures Markets
22 Pages Posted: 17 Apr 2021 Last revised: 1 Jul 2021
Date Written: April 13, 2021
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
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