Intrinsic Storage Valuation by Variational Analysis

TL;DR

This paper formulates and solves the intrinsic storage valuation problem using variational analysis, revealing how constraints influence optimal strategies and the close relationship between intrinsic and stochastic solutions.

Contribution

It introduces a variational analysis approach to intrinsic storage valuation, providing insights into the effects of constraints and the connection to stochastic solutions.

Findings

Optimal stochastic exercise decisions are close to intrinsic solutions.

Solution depends on carry cost and cycle constraints.

Provides implicit but insightful characterization of optimal strategies.

Abstract

The mathematical problem concerning intrinsic storage optimisation is formulated and solved by means of variational analysis. The solution, though obtained in implicit form, still sheds light on many important features of the optimal exercise strategy. It is shown how the solution depends on different constraint types including carry cost and cycle constraint. Additionally, the relationship between intrinsic and stochastic solutions is investigated. In particular, we show that the optimal stochastic exercise decision is always close to the intrinsic one.