Minimal variance hedging of natural gas derivatives in exponential Lévy models: theory and empirical performance

Ewald, C.-O. , Nawar, R. and Siu, T.K. (2013) Minimal variance hedging of natural gas derivatives in exponential Lévy models: theory and empirical performance. Energy Economics, 36, pp. 97-107. (doi:10.1016/j.eneco.2012.12.004)

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Abstract

We consider the problem of hedging European options written on natural gas futures, in a market where prices of traded assets exhibit jumps, by trading in the underlying asset. We provide a general expression for the hedging strategy which minimizes the variance of the terminal hedging error, in terms of stochastic integral representations of the payoffs of the options involved. This formula is then applied to compute hedge ratios for common options in various models with jumps, leading to easily computable expressions. As a benchmark we take the standard Black–Scholes and Merton delta hedges. We show that in natural gas option markets minimal variance hedging with underlying consistently outperform the benchmarks by quite a margin.

Item Type:Articles
Status:Published
Refereed:Yes
Glasgow Author(s) Enlighten ID:Ewald, Professor Christian
Authors: Ewald, C.-O., Nawar, R., and Siu, T.K.
College/School:College of Social Sciences > Adam Smith Business School > Economics
Journal Name:Energy Economics
ISSN:0140-9883

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