Convenience Yield Model with Partial Observations and Exponential Utility

We consider the problem of hedging and pricing claims for delivery of crude oil or natural gas to a given location. We work with a three factor model for the asset spot, the convenience yield and the locational basis. The convenience yield is taken to be unobserved and must be filtered. We study the value function corresponding to utility pricing with exponential utility. Assuming the basis is independent from the spot, the partially observed stochastic control problem can be expressed as a closed-form expectation. We show how to numerically compute this expectation using a Kalman or particle filter. The basic model may be generalized to include nonlinear dynamics and further dependencies. We compute a set of numerical statics and we compare our results in the partially observed case to those of the full information case. convenience yield, filtering, partial observations, stochastic control, utility pricing, HJB equation