Pricing Electricity Swaptions under a Stochastic Volatility Term-Structure Model

Författare

Rikard Green
Karl Larsson
Marcus Nossman

Summary, in English

This paper suggests a stochastic volatility

term-structure model applied to the pricing of electricity

swaptions in the Nord Pool market. The volatility structure in the

model is specified as a product of a time-dependent function that

handles the maturity effect, and a Cox-Ingersoll-Ross process that

captures the volatility smile. We employ a Fourier based approach

to price electricity swaptions and perform an empirical analysis

by calibrating the model to a data set consisting of more than

12000 implied volatilities corresponding to swaption prices from

the Nord Pool market. To our knowledge this is one of the first

studies of the volatility smile in the market for electricity

swaptions. We show that our model outperforms the log-normal

benchmark in-sample and out-of-sample.

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