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Pricing a class of exotic commodity options in a multi-factor jump-diffusion model

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Crosby, John

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Abstract A recent paper, Crosby (2005), introduced a multi-factor jump-diffusion model which would allow futures (or forward) commodity prices to be modelled in a way which captured empirically observed features of the commodity and commodity options markets. However, the model focused on modelling a single individual underlying commodity. In this paper, we investigate an extension of this model which would allow the prices of multiple commodities to be modelled simultaneously in a simple but realistic fashion. We then price a class of simple exotic options whose payoff depends on the difference (or ratio) between the prices of two different commodities (for example, spread options), or between the prices of two different (ie with different tenors) futures contracts on the same underlying commodity, or between the prices of a single futures contract as observed at two different calendar times (for example, forward start or cliquet options). We show that it is possible, using a Fourier Transform based algorithm, to derive a single unifying form for the prices of all these aforementioned exotic options and some of their generalisations. Although we focus on pricing options within the model of Crosby (2005), most of our results would be applicable to other models where the relevant “extended” characteristic function is available in analytical form.
Classification Financial Planning, Accountancy; Economic Statistics, Econometrics, Business Informatics
Method theory application
Free Keywords Commodity options; Option pricing; Commodity prices; Continuous time finance; Jump-diffusion; Commodity derivatives; Pricing of derivatives
Document language English
Publication Year 2008
Page/Pages p. 471-483
Journal Quantitative Finance, 8 (2008) 5
Status Postprint; peer reviewed
Licence PEER Licence Agreement (applicable only to documents from PEER project)