Cutting edge: Valuation and optimal hedging of storage contracts in incomplete gas markets

In this paper, Magnus Wobben, Tilman Huhne, Yuri Ivanov and Sebastian Hanneken examine the impact of market incompleteness on the valuation of gas storage contracts. In contrast to prior research, their proposed valuation framework accounts for the contract owner’s individual risk tolerance, which endogenously determines the optimal hedge

Cyclical gas consumption, as well as limited and lagged adjustments of gas supply (for example, caused by increased production), lead to drastic price movements with uncertain volumes. As a suitable means to hedge against those uncertainties, virtual and physical gas storage contracts are becoming more and more important (see Eydeland & Wolyniec (2013) for market fundamentals, as well as standard pricing and hedging approaches).

However, a market-coherent valuation and replication of these