Locational Spread Options with Stochastic Correlation
Date
2023-05-05
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Abstract
Contrary to the common assumption, the correlation between financial derivatives may not be constant across time. This thesis analyses the role of stochastic correlation in modeling for locational spread options for natural gas. We first derive a model with Ornstein–Uhlenbeck process between two spread assets with constant correlation and then a combination of the Ornstein–Uhlenbeck and Jacobi process is used to model a stochastic correlation. The Margrabe formula is employed to evaluate options prices with constant correlation, the solution for which is used to compare with Monte Carlo simulations for stochasticity. Comparing the results, we find out why stochastic correlation is more important in real markets.
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Mathematical Finance
Citation
Ali, S. F. (2023). Locational spread options with stochastic correlation (Master's thesis, University of Calgary, Calgary, Canada). Retrieved from https://prism.ucalgary.ca.