The Valuation of Clean Spread Options: Linking Electricity, Emissions and Fuels

TL;DR

This paper introduces a new structural modeling approach for valuing clean spread options, capturing fundamental economic dependencies more accurately than traditional reduced-form models, demonstrated through numerical examples.

Contribution

It presents a novel pricing method based on structural models for clean spread options, improving the modeling of economic dependencies.

Findings

The new model effectively captures economic dependencies.

Numerical examples demonstrate the approach's accuracy.

The method outperforms traditional reduced-form models.

Abstract

The purpose of the paper is to present a new pricing method for clean spread options, and to illustrate its main features on a set of numerical examples produced by a dedicated computer code. The novelty of the approach is embedded in the use of structural models as opposed to reduced-form models which fail to capture properly the fundamental dependencies between the economic factors entering the production process.