Minimal variance hedging of natural gas derivatives in exponential Levy models

theory and empirical performance

Christian Oliver Ewald*, Roy Nawar, Tak Kuen Siu

*Corresponding author for this work

Research output: Contribution to journalArticle

2 Citations (Scopus)

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.

Original languageEnglish
Pages (from-to)97-107
Number of pages11
JournalEnergy Economics
Volume36
DOIs
Publication statusPublished - Mar 2013

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