When are Swing options bang-bang and how to use it

Details When are Swing options bang-bang and how to use it When are Swing options bang-bang and how to use it

2007-05-03

arxiv.org/abs/0705.0466v1

Mathematics

Probability

28 pages

Scientific paper

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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