Customer Reviews

Energy Risk: Valuing and Managing Energy Derivatives

5 star:		(4)
4 star:		(8)
3 star:		(2)
2 star:		(1)
1 star:		(4)

 

 

Overall a very good book on energy derivatives. The author's pratical experience is very valuable.

But there are quite a few things to improve:

1. The graphs are not good, particularly date axis.

2. Formulae are not typed well, there are some typos. The publisher can certainly uses some improvement. So if possible, derive the formulae by yourself before using them. This may cost you some money !

3. The models described in the books are good, but do not use them blindly. It is better to have have solid derivatives background before using these models. J. Hull's book is a good source.

Again, this is a good book for people with derivatives background. I'd like to see more examples, rigorious treatment of the formulae and expanded modeling techniques.

A must-have for the energy folks...

Any trader or "quant" that has experience in pricing electricity options will appreciate the knowledge contained in Dragana Pilipovic's Energy Risk. The hybrid or "split-personality" nature of energy prices is emphasized throughout the book and is summarized in her two-factor price mean-reverting model. The book's entire exposition from option pricing to risk management is solidly grounded to the first few chapters that introduce Pilipovic's modelling framework.

Although the technical implementation issues are barely described, the information in the first 5 chapter should allow any reasonably numerate analyst to kiss goodbye the ambiguity of double Black-Scholes option valuation in favor of a modelling framework that can be statistically parameterized. It is well known that multi-factor pricing models capture higher order moments in the distribution of commodity prices and a Pilipovic's two-factor model captures the significant high and low frequency information in time-series data. The model lends itself well to parameterization through econometric/statistical means even if some nonlinear estimation techniques are required. The importance of analyzing seasonality in energy markets using statistical techniques is also stressed. In these first chapters (and the Appendix of interest rate models) it is evident that Pilipovic's practical ideology combines the most important elements of equity and interest rate models to tackle energy pricing problems. Although, the fundamental mathematical details are often glossed over (you may need occasional access to Springer-Verlag or other more technical publications), the insights offered in the book will convince any quant of the appropriateness of multi-factor models for the energies.

Chapter 6 provides a very good discussion of volatility term structure and its relationship to mean reversion in prices. The nature of term structure of volatility is extended to two-dimensions ("the volatility matrix") in light of Pilipovic's two-factor framework. There is no doubt that the phrase "volatility surface" is being heard just as much a "volatility curve" in today's trading environment. More mathematically inclined readers will recognize the concepts of serial auto-correlation and conditional volatility inherent in energy price processes although the exposition in the book is really practical.

Chapters 7 and 8 at least provide a decent overview of option pricing; but to make the information dangerous, the reader will likely have to pull his or her copies of Wilmott and Hull off the shelf. The discussion of tree methodologies gives the reader just enough information to wet his appetitite and start re-coding those simple binomial models. The jump to trinomial techniques is not well described but because its there the analyst knows its importance (just see Hull).

Introductory information on option greeks, risk mangement, and portfolio analysis is contained in Chapters 9 to 11. Non-detailed but interesting material includes hedging with different duration contracts, return/risk and minimum variance portfolio objectives. The book has numerous typos but corrections are easily obtained either through the publisher or the author herself. The folks at Sava (Pilipovic's Risk Management shop) are even friendly enough to discuss certain aspects of the technical material contained in the book

I also read all of the reviews before purchasing this book. I particularly noted the wide divergence of opinion on this one and sought to give it a go regardless. I have 15+ years in the Energy sector and financial markets. This book was a big disappointment and I have returned it for a refund. The works by Fusaro and Errera are better choices and Amazon sells them at competitive prices (I have no connection with any authors or publishers).

"Energy Risk" Book Review > > "Although it has been two years since "Energy Risk" was first published, it > still remains one of the key reference books in any well-rounded risk > management library. When a new employee starts for me in the market risk > area, I assign them two books, "Energy Risk" by Dragana Pilipovic and > "Value-at-Risk" by Philippe Jorion. Whether you are modeling energy > instruments, building forward curves or pricing options, "Energy Risk"

> provides the reader with valuable insights into the complexities of energy > commodities and the inherent challenges". > > Mark T. Williams > SVP - Risk Management Group > Citizens Power > Boston, MA

I work in the energy products/generation industry and thought this will help explain what the whole energy-risk field is about. I'm still as confused now as I was before I bought the book .. probably because I dont have a strong background in computational finance. This is defintely not for newcomers and is really geared to the quants.

Dragana's book is a tremendous reference tool for anyone in the energy risk management field. Ms. Pilpovic not only makes this difficult subject easy for the reader, she also provides the detailed math behind the theories. This book was very helpful for both developing our internal risk management systems, as well as describing those systems to regulatory agencies.

It is now a tautology to say that energy derivatives are very important financial instruments. Energizing a market of billions of dollars, they are useful to many different organizations and find their place in myriads of both business and personal portfolios. This book is written for those readers who are just entering the field of energy derivatives, but yet who still have a background in other areas of financial engineering. It emphasizes risk minimization, and also gives some of the author's unique perspective on the subject. Only the first six chapters were read by this reviewer and so only these will be reviewed here.

The first chapter of the book discusses the general properties of energy derivatives and the concept of risk management. The author distinguishes between `quantitative' analysis, which emphasizes the construction of models that replicate market behavior, and `fundamental' analysis, which is an attempt to understand and describe market behavior in terms of the economics of supply and demand. The author emphasizes fundamental analysis in the book. She also outlines what makes energy derivatives unique in their analysis, i.e. what makes them different from interest rate and equity markets in terms of these different analysis categories. Energy markets exhibit stronger mean reversion, she argues, and supply constraints can "shock" the system. These differences motivate the introduction of the topics of `convenience yield' and seasonality that do not have to be used in other types of markets.

Chapter 2 gets into the actual construction of financial models, with the author emphasizing the need for effective benchmarking of these models. She constructs some elementary stochastic price models and introduces some of the basic modeling terminology to be used in the book. One of these concepts is the `convenience yield' that represents the benefit that a holder of a commodity receives by holding the commodity, and is a measure of the balance between the available supply and the existing demand. Defining the convenience yield is difficult, but dominates the mathematical modeling of the energy markets. The author spends a fair amount of time discussing the mean-reversion process with more to come in later chapters. She also discusses the difference between yield and forward rate curves, a forward curve geared toward short-term interest rates, while a yield curve is a discount rate curve representing average rates from the present to points along the time axis.

In chapter 3 the author discusses some of the mathematical/statistical tools involved in energy derivatives, with the analysis of time series and distribution analysis being the two dominant tools that are examined. Time series are used to monitor day-to-day changes in prices, while distribution analysis deals with price levels over extended intervals of time. The material in the chapter is standard, and should be helpful to readers who need a review of it.

Chapter 4 is an introduction to the modeling of spot prices, with the assumption that supply and demand effects converge in the spot market prices. Derivative contracts are bought and sold with the belief that this convergence holds. After a quick look at actual time series of spot prices, the author constructs a lognormal price model and two mean-reverting models. Lognormal price models are of course standard constructions in financial engineering, and are popular for their simplicity and for enforcing positive-definiteness. Negative autocorrelation between spot prices are characteristic of energy markets, and is satisfied in mean-reverting models. The author also introduces one of her models, a two-factor model, with the first factor being the spot price, and the second factor a long-term equilibrium price, which when the latter is zero gives a single-factor model for the energy commodity spot price. Time series analysis is used to obtain the model parameters and distribution analysis is used to test the models over extended time periods. The distribution analysis involves Monte Carlo simulation, and the results showing the differences between actual and sample model simulated distributions.

Recognizing the importance of forward prices in derivatives pricing and risk management, the author gives a detailed treatment of them in chapter 5. The author points out, interestingly, that there is no correlation between energy futures prices to interest rates in the energy commodity markets. The futures and forward prices are valued in an identical manner in energy markets, and energy future price and forward price can be used interchangeably. She also uses the no-arbitrage market condition to show that spot and forward prices are different, and derives partial differential equations for the forward price, both with and without dividends.

Chapter 6 is extremely important, especially for the development of practical trading strategies, for it concerns measures of volatility for price processes. The volatility of the spot price gives information about the degree of randomness in the returns of the spot price over short intervals of time. Traders are of course very interested in volatilities, since the width of the price distribution is related to the probability of the option expiring in-the-money. This is well-known in financial modeling of derivatives, but there are some peculiarities in energy markets, such as "volatility term structure", that make the modeling process more difficult. The author discusses how to calculate historical, market-implied, and model-implied volatilities, and introduces the (two-dimensional) `discrete volatility matrix', the latter of which is due to the author. Several justifications are given for using a two-dimensional matrix of volatilities rather than a single-volatility term structure. The author does not however give any practical reasons for using this matrix or case studies that would illustrate its advantages. Reference is given to a commercial product that uses it, but it would have been helpful to the reader if the author had given more details on its use in practical everyday trading.

I have read other's review on this book, and then purchased the book. Though it contains some useful stories, the book lacks of anything really useful. Lots of comments, math, model without any proof and/or reference. I really wasted my money, and time to read the book witch contains virtually no information.

Pilipovic's book provides a great model for trading energy derivatives. I used it as a starting point to come up with my own models that I have started to use in hedging my risk. I recommend it for both speculators and hedgers.

Quantitative-oriented type of book but real quants will probably find it a bit "light".
The first chapters are supposed to give some background on power, nat gas and oil markets, but there is not much interesting content, which can be summarised like this :"volatility may be very volatile, especially on power, and spot and forward contracts are at best loosely correlated". So nothing really new / interesting unless you are really new to the energy business.
That said, the author proposes an interesting commodity model in the following chapter, and some indsight on model building and validation. Worth a read, but far from a reference book. I would recommend it for a new manager that wants some quick background / crash course on commodity models, to help in discussions with quants and traders.