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15 Mar 08
Author: John Breslin, Les Clewlow, Chris Strickland, Calvin Kwok, Daniel van der Zee
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This article discusses a general multi factor multi commodity (MFMC) model and the process for estimating parameters from historical data. Single factor models have a wide range of applicability in energy valuation and risk management, and are relatively simple to understand and parameterize. However, the simplicity of single factor models can be a double edged sword. While these models can capture much of the dynamics of real life processes in many circumstances, by definition they only use a small amount of the potential information available from the market.
Increasingly, energy risk practitioners are attracted to modelling frameworks that avoid the above simplifications. Where enough data is available, a more general multi factor model can be used to capture extra information about the price dynamics and this is the modelling framework that we concentrate on in this article.
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