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Anatoliy Swishchuk Math & Comp Lab Dept of Math & Stat, U of C ‘Lunch at the Lab’ Talk

Book Review : ‘ Energy Derivatives: Pricing and Risk Management ’ by Clewlow and Strickland , 2000. Anatoliy Swishchuk Math & Comp Lab Dept of Math & Stat, U of C ‘Lunch at the Lab’ Talk November 7 th , 2006. About the Authors: Clewlow, Les. About the Authors: Strickland, Chris.

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Anatoliy Swishchuk Math & Comp Lab Dept of Math & Stat, U of C ‘Lunch at the Lab’ Talk

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  1. Book Review: ‘Energy Derivatives: Pricing and Risk Management’ by Clewlow and Strickland, 2000 Anatoliy Swishchuk Math & Comp Lab Dept of Math & Stat, U of C ‘Lunch at the Lab’ Talk November 7th, 2006

  2. About the Authors: Clewlow, Les

  3. About the Authors: Strickland, Chris

  4. About the Authors: Kaminski, Vince

  5. About the Authors: Kaminski, Vince

  6. About the Authors: Masson, Grant

  7. About the Authors: Chahal, Ronnie

  8. Contents • Preface • 11 Chapters • References: 125 • Index

  9. Chapter 1

  10. Chapter 2

  11. Chapter 3

  12. Chapter 3 (cntd)

  13. Chapter 4

  14. Chapter 5

  15. Chapter 6

  16. Chapter 7

  17. Chapter 8

  18. Chapter 8 (cntd)

  19. Chapter 9

  20. Chapter 10

  21. Chapter 11

  22. Chapter 11 (cntd)

  23. Chapter 1

  24. Ch. 1 (1.1. Intro to Energy Derivatives) • A Derivative Security: security whose payoff depends on the value of other more basic variables • Deregulation of energy markets: the need for risk management • Energy derivatives-one of the fastest growing of all derivatives markets • The simplest types of derivatives: forward and futures contracts

  25. Ch.1 (Forwards and Futures) • A Futures contract: agreement to buy or sell the underlying asset in the spot market (spot asset) at a predetermined time in the future for a certain price, which is agreed today. • A Forward contract: agreement to transact on fixed terms at a future date, but these are direct between two parties. • F=S exp [(c - y) (T-t)]

  26. Ch.1 (Options Contracts) • Two types: Call and Put • Call Options: gives the holder the right, but not obligation, to buy the spot asset on or before the predetermined date (the maturity date) at a certain price (the strike price), which is agreed today. • Differ from forward and futures: payment at the time the contract is entered into (option price)

  27. Ch.1 (Options Contracts II)

  28. F. Black, M. Scholes, R. Merton (1973)-BSM approach SDE (GBM) Ch. 1(1.2. Fundamentals of Modelling and Pricing)

  29. F. Black, M. Scholes, R. Merton (1973)-BSM approach PDE Ch. 1 (1.2. Fundamentals of Modelling and Pricing II)

  30. F. Black, M. Scholes, R. Merton (1973)-BSM approach Solution Ch. 1 (1.2. Fundamentals of Modelling and Pricing III)

  31. Merton (1973) P(T,t)-price at time t of a pure discount bond with maturity date T BSM formula Ch. 1 (1.2. Fundamentals of Modelling and Pricing IV)

  32. Ch. 1 (1.3. Numerical Techniques) • Trinomial Tree Method (this book) • Monte Carlo Simulation (this book) • Finite difference schemes (another one) • Numerical integration (-//-) • Finite element methods (-//-)

  33. Ch. 1 (1.3.1. The Trinomial Method) • Alternative to binomial model by Cox, Ross, Rubinstein (1979): continuous-time limit is the GBM • Provide a better approximation to a continuous price process • Easier to work with (more regular grid and more flexible)

  34. Ch. 1 (1.3.1. The Trinomial Method II)

  35. Ch. 1 (1.3.1. The Trinomial Method III)

  36. Ch. 1 (1.3.1. The Trinomial Method IV)

  37. Ch. 1 (1.3.1. The Trinomial Method V)

  38. Ch. 1 (1.3.1. The Trinomial Method VI)

  39. Ch. 1 (1.3.1. The Trinomial Method VII)

  40. Ch. 1 (1.3.1. The Trinomial Method VIII) (The value of option)

  41. Ch. 1 (1.3.1. The Trinomial Method IX) (‘backward induction’)

  42. Ch. 1 (1.3.1. The Trinomial Method X) (The value of option)

  43. Monte Carlo Simulation (MCS) • MCS: estimation of the expectation of the discounted payoff of an option by computing the average of a large number of discounted payoff computed via simulation • Felim Boyle (UW, 1977)-first applied MCS to the pricing of financial instruments

  44. Monte Carlo Simulation (MCS) II

  45. Monte Carlo Simulation (MCS) III

  46. Monte Carlo Simulation (MCS): Criticisms • The speed with which derivative values can be evaluated (treatment: variance reduction technique) • Inability to handle American options (treatment: combination of tree and simulation)

  47. Summary

  48. The End • Thank You for Your Attention!

  49. Next Talk: Chapter 2: Understanding and Analysing Spot Prices • Speaker: Ouyang, Yuyuan (Lance) • November 17, 2006, 12:00pm, MS 543

  50. Distribution list of Chapters: • Ch 1,3,6-Anatoliy • Ch 2,7-Lance • Ch 4,8-Matt • Ch 5,9-Matthew • Ch 10-Xu • Ch 11-Greg

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