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Pricing of swing options in a mean reverting model with jumps. (English) Zbl 1156.91377
Summary: We investigate the pricing of swing options in a model where the logarithm of the spot price is the sum of a deterministic seasonal trend and an Ornstein-Uhlenbeck process driven by a jump diffusion. First we calibrate the model to Nord Pool electricity market data. Second, the existence of an optimal exercise strategy is proved, and we present a numerical algorithm for computation of the swing option prices. It involves dynamic programming and the solution of multiple parabolic partial integro-differential equations by finite differences. Numerical results show that adding jumps to a diffusion may result in 2-35% higher swing option prices, depending on the moneyness and timing flexibility of the option.

91B28 Finance etc. (MSC2000)
60J65 Brownian motion
90C39 Dynamic programming
Full Text: DOI
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