WHEN ARE SWING OPTIONS BANG-BANG?

Olivier Bardou · Gilles Pagès

42 citations0/0 files storedInternational Journal of Theoretical and Applied Finance

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Stochastic processes and financial applications Capital Investment and Risk Analysis Risk and Portfolio Optimization

Abstract

In this paper we investigate a class of swing options with firm constraints in view of the modeling of supply agreements. We show, for a fully general payoff process, that the premium, solution to a stochastic control problem, is concave and piecewise affine as a function of the global constraints of the contract. The existence of bang-bang optimal controls is established for a set of constraints which generates by affinity the whole premium function. When the payoff process is driven by an underlying Markov process, we propose a quantization based recursive backward procedure to price these contracts. A priori error bounds are established, uniformly with respect to the global constraints.

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References

2004Valuation of Commodity-Based Swing Options 2005A QUANTIZATION TREE METHOD FOR PRICING AND HEDGING MULTIDIMENSIONAL AMERICAN OPTIONS 2008OPTIMAL MULTIPLE STOPPING AND VALUATION OF SWING OPTIONS 2004Optimal Quantization Methods and Applications to Numerical Problems in Finance 2003Monte Carlo methods for the valuation of multiple exercise options 2003Optimal quadratic quantization for numerics: the Gaussian case 2003Error analysis of the optimal quantization algorithm for obstacle problems 2006Numerical Methods for the Pricing of Swing Options: A Stochastic Control Approach

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