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Pricing energy quanto options: a regime-switching framework with stochastic interest rates

par Benth, Fred Espen;Deelstra, Griselda ;Kozpinar, Sinem
Référence Stochastics
Publication Publié, 2025-05-01

Article révisé par les pairs

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Résumé :

Energy quanto options are risk management instruments gaining a lot of attraction from the actors in energy markets due to their nature, which allows to handle volumetric and price risk simultaneously, in contrast to typical contracts that solely take price risk into consideration. The payoff of these options is constructed in such a way that it resembles the product of the payouts from two options, each with an energy-related underlying. If the underlying assets are considered to be energy futures contracts, which are more easily traded assets than temperature and energy spots themselves, the payoff of the energy quanto option can be treated as the product of the payoff of two European vanilla options. This paper investigates the valuation of energy quanto options written on temperature and electricity futures in the presence of regime-switching stochastic interest rates. The electricity futures price is governed by a continuous Markov-modulated model with mean reversion, and the dynamics of temperature futures evolve without regime-switching but retain seasonality and mean reversion. Using a change of measure and fast Fourier transform techniques, we obtain a pricing formula for energy quanto options on futures. Numerical examples are carried out to demonstrate the implementation of the model.