Pricing Electricity Swaptions under a Stochastic Volatility Term-Structure Model

This paper suggests a stochastic volatility
term-structure model applied to the pricing of electricity
swaptions in the Nord Pool market. The volatility structure in the
model is specified as a product of a time-dependent function that
handles the maturity effect, and a Cox-Ingersoll-Ross process that
captures the volatility smile. We employ a Fourier based approach
to price electricity swaptions and perform an empirical analysis
by calibrating the model to a data set consisting of more than
12000 implied volatilities corresponding to swaption prices from
the Nord Pool market. To our knowledge this is one of the first
studies of the volatility smile in the market for electricity
swaptions. We show that our model outperforms the log-normal
benchmark in-sample and out-of-sample.