Pricing of commodity derivatives on processes with memory (1711.00307v1)

Abstract: Spot option prices, forwards and options on forwards relevant for the commodity markets are computed when the underlying process S is modelled as an exponential of a process {\xi} with memory as e.g. a L\'evy semi-stationary process. Moreover a risk premium \r{ho} representing storage costs, illiquidity, convenience yield or insurance costs is explicitly modelled as an Ornstein-Uhlenbeck type of dynamics with a mean level that depends on the same memory term as the commodity. Also the interest rate is assumed to be stochastic. To show the existence of an equivalent pricing measure Q for S we relate the stochastic differential equation for {\xi} to the generalised Langevin equation. When the interest rate is deterministic the process ({\xi}; \r{ho}) has an affine structure under the pricing measure Q and an explicit expression for the option price is derived in terms of the Fourier transform of the payoff function.