Estimation of the Risk Premiums in Energy Markets

43 Pages Posted: 2 May 2005

See all articles by James Doran

James Doran

University of New South Wales

Date Written: April 22, 2005

Abstract

In this paper I attempt to estimate the risk premiums in energy markets using the closing prices from futures and options contracts of natural gas. Solving for the instantaneous parameters is conducted over several parametric models where the results suggest a model that incorporates both return and volatility jumps best captures the return dynamics for this energy commodity. Solving for the market price(s) of risk requires calibrating the model by combining both the risk-neutral and real world distributions. In using both the current futures price and the cross-section of option prices, estimation of the parameters is conducted using a simulated method of moments technique by minimizing the difference between the estimated and actual realized volatility and option prices. A statistically significant negative volatility and price premium for natural gas contracts is found. Controlling for seasonality suggest differences in premia across different seasons, with winter months having higher negative premiums.

Keywords: Risk Premium, Option Pricing, Simulated Method of Moments, Natural Gas

JEL Classification: G12, G13, C15, C52, Q4

Suggested Citation

Doran, James, Estimation of the Risk Premiums in Energy Markets (April 22, 2005). Available at SSRN: https://ssrn.com/abstract=709182 or http://dx.doi.org/10.2139/ssrn.709182

James Doran (Contact Author)

University of New South Wales ( email )

College Rd
Sydney, NSW 2052
Australia

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