V - Advanced Methods and Structures
Published online by Cambridge University Press: 05 June 2014
Summary
The structures that we discuss here in Part V combine all the primary valuation issues discussed in Part III and many aspects of the modeling paradigms described in Part IV. We concentrate on three common types of structures that in many respects continue to challenge portfolio managers and valuation specialists.
Natural gas storage facilities are arguably the most challenging and least resolved class of energy structures in the business. We start with storage primarily because it involves a single commodity; complexities arise for several reasons. First, optionality is high dimensional, occurring at the daily level, and more important, each decision point (exercise time) is coupled with optionality in the future. The decision to inject or withdraw from storage affects the state of the system, specifically how much inventory remains, which changes one's degrees of freedom in the future. This coupling means that valuation depends on correlations between returns of different contracts or delivery periods. However, the market implied correlation information is scarce and often of a nature that is not particularly useful for model calibration or hedging. Finally, storage operators, while competitive, are all attempting to achieve much the same thing. Hence the assumption of no feedback of hedging actions into price dynamics is potentially flawed. There is evidence that returns correlations do, in fact, depend on inventory levels, presenting a modeling problem that has yet to be resolved.
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- Valuation and Risk Management in Energy Markets , pp. 295 - 296Publisher: Cambridge University PressPrint publication year: 2014