-

 

 

 




Optimization Online





 

Indifference pricing of natural gas storage contracts

Nils Löhndorf(nils.loehndorf***at***wu.ac.at)
David Wozabal(david.wozabal***at***tum.de)

Abstract: Natural gas markets are incomplete due to physical limitations and low liquidity, but most valuation approaches for natural gas storage contracts assume a complete market. We propose an alternative approach based on indifference pricing which does not require this assumption but entails the solution of a high-dimensional stochastic-dynamic optimization problem under a risk measure. To solve this problem, we develop a method combining stochastic dual dynamic programming with a novel quantization method that approximates the continuous process of natural gas prices by a discrete scenario lattice. In a computational experiment, we demonstrate that our solution method can handle the high dimensionality of the optimization problem and that solutions are near-optimal. We then compare our approach with rolling intrinsic valuation, which is widely used in the industry, and show that the rolling intrinsic value is sub-optimal under market incompleteness, unless the decision-maker is perfectly risk-averse. We strengthen this result by conducting a backtest using historical data that compares both trading strategies. The results show that up to 40% more profit can be made by using our indifference pricing approach.

Keywords: stochastic-dynamic programming, asset pricing, natural gas industry, Markov processes

Category 1: Applications -- OR and Management Sciences

Category 2: Stochastic Programming

Citation: unpublished: working paper, WU Vienna University of Economics and Business, 02/2017

Download: [PDF]

Entry Submitted: 02/15/2017
Entry Accepted: 02/15/2017
Entry Last Modified: 02/15/2017

Modify/Update this entry


  Visitors Authors More about us Links
  Subscribe, Unsubscribe
Digest Archive
Search, Browse the Repository

 

Submit
Update
Policies
Coordinator's Board
Classification Scheme
Credits
Give us feedback
Optimization Journals, Sites, Societies
Mathematical Optimization Society