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A Numerical Method for Pricing Electricity Derivatives for Jump-Diffusion Processes Based on Continuous Time Lattices

Albanese, Claudio and Lo, Harry and Stathis, Tompaidis (2006): A Numerical Method for Pricing Electricity Derivatives for Jump-Diffusion Processes Based on Continuous Time Lattices.

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Abstract

We present a numerical method for pricing derivatives on electricity prices. The method is based on approximating the generator of the underlying process and can be applied for stochastic processes that are combinations of diusions and jump processes. The method is accurate even in the case of processes with fast mean-reversion and jumps of large magnitude. We illustrate the speed and accuracy of the method by pricing European and Bermudan options and calculating the hedge ratios of European options for the Geman-Roncoroni model for electricity prices.

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