Cutting edge: Impact of execution behaviour on valuation of optional financial contracts

Expected payoff maximisation is a commonly assumed strategy in valuation. S Hossein Hosseini, Qiaoyan Bian, Jay Chen and John Jiang suggest that execution strategies may vary due to complex option structures and their resulting uncertainties. Using a swing option as an example, they illustrate that expected payoff maximisation might lead to higher risk and conclude that the impact of execution strategies should be studied further

In power and energy markets, financial contracts with optionality are often used to accommodate the natural variations of energy consumption or production. Maximisation of the expected payoff of such an optional financial contract is a modelling criterion often used in valuation. However, due to the embedded optionality and the fact that this market is incomplete, the actual behaviour of contract holders during execution may affect the true value in terms of risk. Due to possible differences in