Abstract
In this paper, we study the valuation of swing options on electricity markets with local volume and refraction time constraints, under the setting that the dynamic of the underlying spot price is a 2-state regime-switching mean-reverting process. We derive the corresponding optimal multiple stopping problem, reduce it to a sequence of optimal single stopping problems, and further find that those value functions satisfy HJB variational inequalities subject to suitable conditions. Then after a prior estimation for the value functions, the viscosity solutions approach is adopted to get existence and uniqueness results in viscosity sense.
Highlights
1 Introduction In real electricity markets, swing options provide the holder with rights to exercise repeatedly under certain constraints, such as limits on the local volume, the global volume, and refraction time etc
Besides the specification of option contracts, the other one of fundamental settings of the whole valuation procedure is the dynamic process characterizing the behavior of electricity prices, which remain high for a period of time after a jump, according to the empirical researches like [1,2,3,4] and [5]
Different from the lattice method, another approach to tackling this problem is to seek the PDE characterization of the value function, which leads to the HJB variational inequalities
Summary
In real electricity markets, swing options provide the holder with rights to exercise repeatedly under certain constraints, such as limits on the local volume, the global volume, and refraction time etc. Different from the lattice method, another approach to tackling this problem is to seek the PDE characterization of the value function, which leads to the HJB variational inequalities.
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