On the control of the difference between two Brownian motions: an application to energy markets modeling

Thomas Deschatre

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arXiv · 2101.03041

On the control of the difference between two Brownian motions: an application to energy markets modeling

Thomas Deschatre

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Abstract

We derive a model based on the structure of dependence between a Brownian motion and its reflection according to a barrier. The structure of dependence presents two states of correlation: one of comonotonicity with a positive correlation and one of countermonotonicity with a negative correlation. This model of dependence between two Brownian motions $B^1$ and $B^2$ allows for the value of $\mathbb{P}\left(B^1_t - B^2_t \geq x\right)$ to be higher than $\frac{1}{2}$ when $x$ is close to 0, which is not the case when the dependence is modeled by a constant correlation. It can be used for risk management and option pricing in commodity energy markets. In particular, it allows to capture the asymmetry in the distribution of the difference between electricity prices and its combustible prices.

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Thomas Deschatre. 2021-01-08. On the control of the difference between two Brownian motions: an application to energy markets modeling. https://arxiv.org/abs/2101.03041

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