Merchants operations involves valuing and hedging the cash flows of commodity and energy conversion assets as real options based on stochastic models that inevitably embed model error. In this paper we quantify how empirically calibrated model errors about the futures price term structure affect the valuation and hedging of commodity storage assets, specifically the storage of natural gas, an i...

Quadratic hedging of option payoffs generates the variance optimal martingale measure. When an features exercise policy and its cash flows are hedged according to this approach, it may be tempting optimize such a under Because measure not equivalent probability measure, focusing on American options we show that resulting unappealing. This drawback can sometimes remedied by imposing time consist...

In financial markets, errors in option hedging can arise from two sources. First, the option value is a nonlinear function of the underlying; therefore, hedging is instantaneous and hedging with discrete rebalancing gives rise to error. Frequent rebalancing can be impractical due to transaction costs. Second, errors in specifying the model for the underlying price movement (model specification ...

The collateral choice option allows a collateral-posting party the opportunity to change type of security in which is deposited. Due nonzero basis spreads, this optionality significantly impacts asset valuation. Because complexity valuing option, many practitioners resort deterministic assumptions on rates. In paper, we focus valuation model based stochastic dynamics. Intrinsic differences resu...