McMaster University, December 5 - 8, 2014
The spread between two related energy prices is a very important quantity throughout energy finance. Of particular interests are the spread between two different energy types, location spreads, and calendar spreads.
At times it is appropriate to consider the spread as a distinct process from the underlying price processes which can be modelled directly. We introduce a new mean-reverting random walk, derive its continuous stochastic differential equation and obtain some analytical results about its solution. This new mean-reverting process is compared with the Vasicek process and its advantages discussed. Since the analytical transition density does not exist for this nonlinear stochastic process, to estimate the model parameters, the local linearization method is deployed. We apply this method to empirical data for modeling the spread between West Texas Intermediate (WTI) crude oil and West Texas Sour (WTS) crude oil.
This is joint work with Mehran Moghtadai, MSc.
Our findings have important consequences for damages assessment and allocation of settlement awards in securities class actions. In some jurisdictions damages awarded are net of any hedge or risk-limitation transaction. Since corporate securities such as bonds, stocks and warrants are often held in portfolios for hedging purposes, measuring the effect of misrepresentation on all of the firm's issuances is essential to accurately computed damages awards. Additionally our approach provides a consistent methodology for computing damages for securities that do not trade on public markets. A case study of a recent securities class action illustrates our methodology.