Cutting Edge: Pure jump models for energy prices

Université de Lausanne’s Roberto Marfè investigates pure jump processes as modelling blocks for the distributions of energy returns under the pricing measure. An easy-to-implement option-implied approach is outlined, which circumvents most of the estimation difficulties found for other models. A subsampling procedure rules out the distortive effects of seasonality. It is demonstrated that Lévy models overperform the jump-diffusion approach and capture the volatility surface

Pure jump models for energy prices

Commodity markets differ from stock and bond markets in several key properties. Supply is determined by production and inventory, with the presence of a quantity risk. Demand is generally inelastic to prices: this is due to essential nature of considered good. The balance of supply and demand can be smoothed by inventories. Non-storability, which uniquely characterises electricity, involves the real-time balancing of supply and demand.

The continuous rebalancing of supply and demand

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