BFS 2002

Contributed Talk

Network commodities, e.g.point-to-point bandwidth capacity, are commodities whose substitution possibilities can be described using a network graph. This means that the price dynamics of individual commodities is influenced by each other according to the network structure. We describe an adapted form of the HJM model, the network-HJM model, which directly includes the graph of substitution possibilities in the forward price dynamics. In analogy with the standard HJM model a drift term is required to maintain the martingale property of the forward prices but in this case it relates to the effects of the network structure. We consider the network structure as a pricing opportunity and demonstrate option designs which are separately sensitive to the network existence and to details of network topology.