Pricing commodity futures options in the Schwartz multi factor model with stochastic volatility: An asymptotic method

Chen, J. and Ewald, C.-O. (2017) Pricing commodity futures options in the Schwartz multi factor model with stochastic volatility: An asymptotic method. International Review of Financial Analysis, 52, pp. 144-151. (doi:10.1016/j.irfa.2017.05.002)

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Abstract

In this paper we investigate the applicability of the asymptotic approach developed in Fouque et al. (2000) for pricing commodity futures options in a Schwartz (1997) multi factor model, featuring both stochastic convenience yield and stochastic volatility. We show that the zero order term in the expansion coincides with the Schwartz (1997) two factor term, with expected long-term volatility replacing the constant volatility term, and provide an explicit expression for the first order correction term. Using empirical data from the natural gas futures market, we demonstrate that a significantly better calibration can be achieved by involving the correction term as compared to the standard Schwartz (1997) two factor expression. This improvement comes at virtually no extra effort.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Ewald, Professor Christian and CHEN, JILONG
Authors: Chen, J., and Ewald, C.-O.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:International Review of Financial Analysis
Publisher:Elsevier
ISSN:1057-5219
ISSN (Online):1873-8079
Published Online:27 May 2017
Copyright Holders:Copyright © 2017 Elsevier Inc.
First Published:First published in International Review of Financial Analysis 52: 144-151
Publisher Policy:Reproduced in accordance with the publisher copyright policy

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